Monday, October 17, 2016

Recent Option Transaction

option strategy, call options, option seller, dividend growth investing
Target Corporation (TGT) November 25, 2016 $74 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.  

Over the last couple months I've been much more active in the options market.  My normal strategy is to sell puts on companies that I want to own anyways whenever I can find attractive scenarios.  In my view, getting paid to set a limit order or buying shares at a discount is the best of both worlds.

Selling puts is my normal strategy, although every now and then I do sell call options on some of my existing holdings.  Back in September I sold a call on Target Corporation (TGT) and generated a decent 0.44% return in about 9 days and the best part is that I still own the shares.

Last week I went back to that well by selling another call option on Target.    

What'd I Do?

On Friday, October 14 I sold to open 1 call option on Target Corporation.

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

Company: Target Corporation (TGT)
Date Opened: 10/14/2016
Expiration Date: 11/25/2016
Strike Price: $74.00
Price of Contract: $0.28
Premium Received less Commission/Fees: $20.00
Share Price at Time Contract Sold: ~$68.41

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 you givethem the right to purchase 100 shares per contract of a given company at an agreed 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 Target's share price is less than $74 between now and the expiration date I'll get to keep the premium as cash as just a bonus return.  That works out to a relatively meager 0.27% return.  Even when we account for the return being earned in about 1.5 months the annualized return only works out to 2.35%.  

If the share price is trading above $74 between now and expiration then I'll likely have to sell 100 shares of Target at $74 per share.  However, since I received the premium up front my effective sale price would be $74.20 per share plus I would likely receive the next dividend payment of $0.60.

If Target'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, Target
Target Corporation (TGT) November 25, 2016 $74 Strike Call Option Profit/Loss Graph
Why risk losing the shares?

As I mentioned earlier my typical play in the options market is to sell put options; however, with 3 different puts currently open and me potentially being on the hook to purchase almost $19k worth of equities I'm a bit tapped right now from continuing with that strategy.  Since I own over 100 shares of Target I figured that I might as well put them to work and generate some extra income from them which led me to write another call.

I do have to admit that this is a bit of a bet that Target won't see significant appreciation over the next 1.5 months.  That strays a bit from my normal call selling plan that incorporates a valuation component.  However, I feel that it's a fairly calculated bet.

So what has to happen in order for me to have my shares called away?  Well, at the time that I sold the call option the share price of Target was trading around $68.41.  I only have to sell my shares if the share price climbs over 8% in about 1.5 months.  While that's certainly possible I think it's rather unlikely given the ongoing issues at Target.  

Even if the share price does climb above $74 by late November I would venture to guess that's about the max that shares could appreciate unless they report absolutely banner earnings on November 16.  Considering that I've kept my wife out of Target, not for any reason other than every trip is $100+, for much of the last month maybe they won't report record breaking numbers.

While I don't want to lose my shares of Target I think it was a decent opportunity to pick up a few bucks from Mr. Market.  I can live with having to sell my shares considering the worst case scenario, in my eyes, is that I happen to sell my shares and raise some cash in a frothy market.  That's not exactly a bad place to be.

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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  1. Good trade. I seriously doubt that TGT will be over $74 next month. It seems like easy money to me.

    1. OH,

      Yeah that was my thought and if it happens to move up 8% then so be it because I wouldn't mind building some cash anyways especially since TGT is likely to still have just so-so results for a bit.

      Thanks for stopping by!