Tuesday, February 4, 2014

Lots of options

No this post isn't about all the great investment opportunities that Mr. Market is giving us, it's about all of my recent option trading/selling activity.  There's been a lot more activity on this front than I expected to be reporting.  My goal is to receive $1,500 in profit from option selling this year and I'm getting off to a decent start.  I've got two closed/expired positions to update all of you on as well as two new positions.

This past Friday marked the expiration date for the call option I sold on Halliburton (HAL).  Every quarter I receive more shares of Halliburton through the ESPP program at work so I want to try and divest those funds into other investments.  I prefer to sell calls until the shares are called away to generate extra income on top of the dividends that they provide.  On January 22nd I sold the $51 strike call option expiring on January 31st.  In return for selling the option I received $46.00 in option premium to do as I wanted.  The shares were trading below $51 on expiration so I got to keep the full option premium as profit.  This is a $46.00 / $5,100 = 0.90% return in about 1.5 weeks.  That's equivalent to at 36.60% annualized return.  If only I could do that every 10 days and I would be one happy investor.  I expected the shares to hover around the $51 mark and would then just sell another call if the shares weren't called away, but we all know how the markets decided to end January.  This brought the price of Halliburton down into the $48.50 range so in hindsight I left some money on the table.  I'll still look for opportunities to sell another call option because I need the capital from those shares for other investments, possibly a rental property.

On December 4th I sold a $24 strike call option and received $65.01 in option premium after commission and fees.  I never got a post written up about selling this call option and for that I apologize, but the holidays and more interesting posts kept me busy.  The option was set to expire on February 22nd, but I might not have the time to wait in case there's continued weakness.  Intel has struggled mightily with the adoption of the mobile platform and announced yet another quarterly dividend of $0.225.  That would be seven quarters now.  Not exactly a dividend growth stock but they still have until later this year to keep their streak alive.

Yesterday I bought to close the call option for $43 which cost $50.99 after commission and fees.  Subtracting this from the premium I received netted me a profit of $14.02 in just about 2 months.  That's a $14.02 / $2,400 = 0.58% return which is equivalent to a 3.50% annualized rate.  Not exactly the best return but a profit is a profit and closing out the call option gives me the freedom to sell the shares outright or sell another call option that is further in the money.  I just don't think that Intel has a place in my portfolio any longer and there's better opportunities out there.  It seems that it's always the next quarter when Intel is going to take off, and then the next quarter, and then the second half of next year.  I'm tired of waiting, especially if they won't give the token increase to keep me somewhat appeased.

On the continued weakness this past Friday I decided to leverage up a bit and sell two put options.  The first put option was a $39 strike put on Coca-Cola (KO) that expires on August 16th.  I received $2.69 which works out to $260.25 after commission and fees.  This option can work out one of three ways.

(1)  If shares of KO trade higher than $39 between now and expiration I'll get to keep the full option premium as profit.  This would be a $260.25 / $3,900 = 6.67% return in about 7 months.  That would be a 12.36% annualized return.

(2)  If shares of KO are trading below $39 between now and expiration I'll be forced to purchase 100 shares for $39.00 each.  However, since I received the $260.25 in option premium I get to subtract that from my cost basis.  That would give me an adjusted cost basis of $36.49 per share.  Based on the current annual dividend of $1.12 that would be a 3.07% YOC, but KO should be announcing an increase later this month to around $1.20.  That would make the YOC 3.29%.

(3)  If shares of KO trade sharply higher between now and expiration I can buy to close the option for a profit less than in scenario 1.

I sold this put on margin so the actual cash that is required to hold the position is only around $1,200 instead of $3,900 for a cash secured put.  I'll be happy either way the option goes but if it's short term then I'd prefer for scenario 3 where shares trade higher rather quickly.  Over the long term I'd prefer scenario 2 to get a great YOC on a great dividend growth company.  However, my guess is that scenario 1 or 3 is what ends up happening.

The second put option that I sold was on Phillip Morris (PM).  The weakness is PM's share price has been well documented and honestly quite surprising to me.  I still want to add some shares here because over the long term I feel this is a great entry price as the yield is essentially 5.00% based on yesterday's closing price.  I sold the $82.50 put option that is set to expire on January 17, 2015.  In exchange for selling the option I received $941.24 after commission and fees.  This option can work out one of three ways.

(1)  If shares of PM trade higher than $82.50 between now and expiration I'll get to keep the option premium as profit.  This would be a $941.24 / $8,250 = 11.41% return in essentially 50 weeks.  That would be equivalent to a 11.86% annualized return.

(2)  If shares of PM trade lower than $82.50 on expiration I'll be forced to purchase 100 shares for $82.50.  However I get to subtract the option premium from the strike price which would give me a $73.18 per share cost basis.  Based on the current annual dividend of $3.76 my YOC on this lot of shares would be 5.14%.

(3)  If shares of PM trade sharply higher then I can close out the option for a profit less than scenario 1.

Ideally I'd like shares of PM to close at $82.49 on expiration day but we'll see how things work out.  My guess is that scenario 3 works out on this option, just like the KO option above.  I sold this put on margin as well so the actual cash requirement is only around $2,900 rather than the $8,250.  So my returns will be much higher if I close out the position or it expires worthless.

Given the long times until expiration, I expect to close out both the KO and PM put options early once the markets move into some calmer waters.  But volatility is great for the option seller as it juices up the premiums.  I now have three open put options counting the two from this past Friday and the one on Realty Income (O) that I sold in early December.

I mentioned that there's plenty of other opportunities in the markets right now and of course there's the rental property that I'm very interested in getting.  I'm leaning towards closing out the Realty Income put option early to try and limit my exposure to real estate in case I do move forward on the rental.  I've got a post detailing the property coming up tomorrow morning so be on the lookout for that.

So far in 2014 I've received $170.29 in profits from options.  I've updated my Option Summary page to reflect the changes.

10 comments:

  1. Wow JC, you have been busy. Nice work on the options income....well on your way to exceeding your 2014 goal. I had to chuckle because you touched on "the dream" for income investors. If we could consistently roll our investments every week to generate 1% returns.....what a wonderful world it would be :o) Alas, no. But it looks like you know how to play the options game. Rock on
    -Bryan

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    1. Bryan,

      Yeah the last few weeks have been a lot busier for my portfolio than I expected or really even wanted. I don't count the premiums as earned until the position is closed either by expiration or I buy to close the option. So these are paper gains right now.

      We'll see how these work out but my guess is I close them out early once the markets get a little more sane. This is a bit riskier than I normally like to be because I don't have the capital to back up the puts should they be executed early. Given the long lead time before they both expire I wouldn't expect that to happen unless the markets sell off another 10%+ from here. Hopefully that's not the case though. At least not until I can build up some cash.

      Thanks for stopping by!

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  2. Love the PM put out of the two put; not that either trade is bad, just a better trade IMO. Not every day you set yourself up for a $940 dollar potential win, especially given the low capital requirements due to margin.

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    1. w2r,

      I like the PM put the most as well because it offers a great return if I hold through expiration. Almost a $1k gain sure would be nice and that by itself would get me almost 2/3 of the way towards my option income goal for the year. I think both will end up getting bought back early though unless the markets have a horrible year.

      Thanks for stopping by!

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  3. One of these days I'll have to pick your brain about the best way to take advantage of my company's ESPP. We get to purchase at a 15% discount (with a 6 month lookback option) and can sell immediately afterwards, but then that discount itself becomes taxable income. Right now, we're just dipping our toes in the water as we're more index investors than single stock. But it might make sense to make big purchases, then immediately sell out.

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    1. Done by Forty,

      Since you can get a 15% discount and sell immediately, I think it's a no brainer to at least put some money into the ESPP. It's hard to beat a 15% discount. It all depends on your comfort level with owning company stock, which I don't recommend holding too much because I'd hate to be in the situation where I get laid off because the company is struggling and a huge chunk of my investments are going down too. If when you buy shares you're able to pick up lots of 100+ shares then I prefer to sell call options. It might take longer to diversify but you can generate extra income/return that way. If you get less than 100 share lots then it's really up to whether you think the share price will climb and you want to wait for the next purchase to go through so you can sell calls or you can just sell right away. ESPP's are a great bonus for those that have them as an option. If you have any other questions feel free to ask. I've got a spreadsheet to calculate the taxes which are a headache since some is counted as income and some is counted as capital gains.

      Thanks for stopping by!

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    2. That's good advice. I am currently contributing 1% of gross, which is like just putting it in cash for 6 months, and then every six months they make a purchase. Ought I be concerned about opportunity costs, if I really load up on this?

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    3. If that's money that is going to be invested anyways then the chances of you beating that through whatever other investment are pretty slim. Your return assuming that the discount is based off the current price is actually 17.6% even though you get a 15% discount. Do you realistically think you can beat 17.6% every 6 months? Even accounting for taxes if you're selling right away that's a 13.2% return if you're in the 25% bracket.

      But you have to figure out what's best for you and if you don't want further allocation to your employer since they are also your source of income that's understandable to not want to use the ESPP. But from a strictly investment basis I think the ESPP is a winner.

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  4. I did the KO option trade as well, it did slip some more and I'm thinking about selling another put. I've always wanted to own Coca cola but at a great price.

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    1. Marvin,

      Same expiration and strike? This is a pretty good price to be buying outright so if the option happens to be executed it'll be a great price. Unfortunately I don't expect the put to be executed because there's the dividend increase soon which should form a higher support and I expect the markets to turn back in the black throughout the year. Of course, the timing of that move is unknown.

      Thanks for stopping by!

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