I have another option trade to report from yesterday. I've been wanting to pick up some more shares of Wells Fargo and was about to before it's recent climb up off from around the $35 level. Wells Fargo, like the rest of the financial sector, had been under a lot of pressure from the financial crisis but has since returned to being a leader of the industry. The are probably the most conservative of the too big to fail banks and if it's good enough for Warren Buffet who am I to go against him.
I decided to sell the $37 July 20th put option on Wells Fargo. In exchange for selling someone the right to sell their shares to me I received an option premium of $1.63 per share. After accounting for commission and fees of $8.19 I received a total of $154.81 to use now as I please. I chose the July 20th put option since the expiration date will have the shares put to me before the ex-div date in time to receive their September payout. Of course this assumes that they continue to follow the same schedule as the last 2 years for dividend record and payment dates.
This trade can go 1 of 3 ways.
(1) If Wells Fargo is trading below $37 on July 20th, the shares will be put to me meaning I'll have to buy 100 shares for $37.00 each. However, since I've received option premium I can back that out from the strike price. My cost basis for these shares if executed will be $37.00 - $154.81 / 100 + $7.95 / 100 = $35.53. Based on the current annual dividend of $1.00 per share this would give a YOC of 2.81%.
(2) If Wells Fargo is trading above $37 on July 20th, the option will expire worthless. This would mean I'd get to keep the full premium of $154.81 as profit. My return is calculated as $154.81 / $3700 = 4.18% which is annualized to a 11.75% return. Not bad considering I'm essentially setting a limit order to purchase at a price I'm comfortable and getting over a 10% return while I wait.
(3) If Wells Fargo makes a big move up in price, then the cost of the option will drop. I could then repurchase the option to close out the position and redeploy the cash elsewhere.
All the outcomes are favorable to me. I can purchase the shares at a price I would have bought anyways or I can receive a greater than 10% annualized return on my money. I'm expecting a second dividend increase this year from Wells Fargo which will help to prop up the share price. If I could choose how it would play out, WFC would be trading at $36.99 on expiration and the shares would be put to me at a big discount. We'll see how it plays out.
This was my second trade done on margin and will be the last one until some of my cash secured puts are closed out or more cash can be added to the account. For an explanation of margin and how it works check out this post here. To meet the maintenance margin requirements I currently have to hold $1,072.25 in my account to secure the put, much less than the $3,700 required for the cash secured route.
I've updated my Option Summary page to reflect this trade.