Thursday, October 13, 2016

Recent Option Transaction

option strategy, call options, option seller, dividend growth investing
The Coca-Cola Company (KO) May 2017 $44 Strike Call Option
As part of running this blog that chronicles my journey to financial independence I like to be open and honest with all of my transactions.  Typically that revolves around buying shares of high quality companies that I deem to be at fair value or less.  And occasionally there's a sale of a company like when I closed one of my positions earlier this month.  Being open about the moves I make allows for better discussion with all of you and helps spread ideas around.  If it creates my own "investment journal" to detail why I made the move and my expectations, well that's even better.  

If you've been following closely over the last month or so you've probably noticed an uptick in market activity for me.  Although that increase in activity hasn't been related to outright purchases on the market, rather I've been focused a lot more on the options market.  In October alone I've sold 2 put options, one on Altria (MO) and one on Digital Realty (DLR), where I got to collect premium up front in exchange for possibly having to purchase shares at some point in the future.

Typically my options moves are geared towards selling puts; however, yesterday I went a different route and sold a call option on a Dividend Champion.  


What'd I Do?

On Wednesday, October 12 I sold to open 1 call option on The Coca-Cola Company (KO).

Let's go over the pertinent details and then move on to the various ways this can play out.

Company: The Coca-Cola Company (KO)
Date Opened: 10/12/2016
Expiration Date: 5/19/2017
Strike Price: $44.00
Price of Contract: $0.92
Premium Received less Commission/Fees: $84.00
Share Price at Time Contract Sold: ~$41.67

How can this play out?

Since I don't normally sell call options let's go over how exactly they work.  When you sell someone a call option I'm giving someone the right to purchase 100 shares per contract of a given company at an agree upon price, the strike price, on or before the contract expiration date.  However, I'm not going to just do that for free so I receive the option premium up front in exchange for giving someone the right to buy my shares.

If Coca-Cola's share price is less than $44 between now and the expiration date I'll get to keep the premium as cash and sort of a synthetic dividend.  That works out to a 1.91% return/3.31% annual based on the strike price or a 2.02%/3.38% based on the price when the contract was written, ~ $41.67.  The current yield on Coca-Cola shares is 3.35% so I've essentially doubled my dividend yield assuming the contract expires.

If the share price is trading above $44 between now and expiration then I'll likely have to sell 100 shares of Coca-Cola for $44.  However, since I received the premium up front my effective sale price would be $44.84 per share plus I'd also receive 2 dividend payments if it goes all the way to the expiration date.

If Coca-Cola's share price declines or the time value erodes as we move forward then I can also buy back the option to close the position and profit the difference in premium.  

In graphical form this is how this call option looks.

call option, option strategy, dividend growth investing, Coca Cola, synthetic dividend
The Coca-Cola Company (KO) May 19, 2017 $44 Strike Call Option Profit/Loss Graph

Why risk losing the shares?

Ideally I'd just collect the premium either at expiration or closing out the position early and call it a day.  However, since I have no idea where the stock market will go from here there's also the very real risk that I would be forced to sell my shares at $44.  

Although I don't see that as much of an issue for various reasons.  One I expect to see downside volatility depending on the election result and if/when the Fed raises interest rates.  Coca-Cola likely won't see it's shares move as much as other interest rate sensitive securities, but it will likely be dragged down with the rest of them if that happens.

Foreign exchange continues to be a large drag on Coca-Cola and I expect that to even out over the long run.  However, looking out over the next few years my gut says that the USD stays where it is or continues to get stronger and thus reducing Coca-Cola's numbers even more.

Management is guiding to $2.00 EPS for full year 2016 which would put the valuation at the time of sale, on a trailing basis, at 22.  That's not exorbitant, but feels a bit pricey to me given the headwinds that I see on both a company and global economy basis.  In hindsight I should have put this trade on earlier this year when the share price was hovering around the $46 level, but for some reason or another didn't.  Live and learn.

Like I mentioned earlier my ideal situation is to just collect my premium and call it a day.  In the case of the shares being called away I'm okay will selling my shares at the $44 level and when you include the option premium you're looking at 7.6% upside protection from the recent $41.67 share price.  

I've updated my Option Summary page to reflect this change.

Do you incorporate an option strategy with your portfolio by selling covered calls or writing puts?

Please share your thoughts below!

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2 comments:

  1. Passive Income Pursuit,

    I sell puts mostly and sometimes sell cover calls. I had recent success in selling puts in RY, in which the option has not been assigned. So I collected premium about 5 or 6 times in the past few months selling a put option in RY.

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  2. It's good to see how everybody is using different strategies to generate more income. We argued about using options, but (for now) it's not very attractive due to our smaller positions. We currently own only 2 companies of which we have more than 100 shares. If the portfolio continues to grow, we might start in a few years though. If we go along, we would be more interesting in selling covered calls.

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