Thursday, August 17, 2017

Established Covered Calls in Applied Materials Inc.

Today, a covered calls position was established in Applied Materials Inc. (ticker symbol AMAT) with an August 25, 2017 expiration and at the $43.00 strike price.  This position has an upcoming quarterly ex-dividend on August 22nd of $.10 per share, so the potential return-on-investment result at expiration includes this dividend.  Given the Covered Calls Advisor's current overall market outlook, an in-the-money covered calls position was established. 

As detailed below, a potential return-on-investment result is an absolute return of  +2.5% which is equivalent to +100.3% annualized return over the next 9 days) if the stock is assigned on the August 25, 2017 options expiration date.
Applied Materials did report quarterly earnings after market close today.  I decided to go forward and establish this position because: (1) AMAT's four largest semiconductor equipment competitors (ASML, LRCX, KLAC, and TER) have already reported earnings and they each soundly beat analysts' EPS expectations (by from 2.8% to 8.0%), so I expected AMAT to do the same; and (2) the implied volatility had expanded to a very high 45.2 which is much higher than the Covered Calls Advisor would have expected for a company that is so closely covered by so many analysts (21 at present) and for which the expected EPS range was relatively narrow at $.82 - $.86.  Here's a short news summary related to Applied Materials' earnings report today:

Applied Materials Posts Better-than-Expected Q3 Results, Q4 Guidance                                      
04:04 PM EDT, 08/17/2017 (MT Newswires) -- Applied Materials (AMAT) reported Q3 revenue of $3.74 billion, up 33% year-over-year and ahead of the analyst consensus of $3.68 billion on Capital IQ. Earnings were $0.86 per share, up 72% year-over-year and topping the Street view of $0.83 per share.
For Q4, the company expects sales in the range of $3.85-$4.0 billion, vs. the analyst consensus of $3.71 billion. Non-GAAP earnings are seen at $0.86-$0.94 per share, vs. expectations for $0.82 per share.

AMAT shares are up more than 3% on 1.1 million shares in aftermarket trading as of 5:00pm today.

Details for this position as well as a possible return-on-investment outcome is provided below.

Applied Materials Inc. -- Covered Calls Position Established
The transactions were:
08/17/2017 Bought 500 AMAT shares @ $43.60
08/17/2017 Sold 5 AMAT Aug 25, 2017 $43.00 Call options @ $1.55
Note: a simultaneous buy/write transaction was executed.
08/22/2017 Upcoming quarterly ex-dividend of $.10 per share

A possible overall performance result (including commissions) for this Applied Materials covered calls position is as follows:
Covered Calls Position Cost Basis: $21,033.30
= ($43.60 stock price -$1.55 options price) *500 shares +$8.30 commissions

Net Profit:
(a) Options Income: +$775.00
= ($1.55*500 shares)
(b) Dividend Income (If AMAT assigned at Aug 25th, 2017 expiration): +$50.00
= ($.10 dividend per share x 500 shares)
(c) Capital Appreciation (If AMAT assigned at $43.00 strike price at Aug 25th options expiration): -$304.95
= ($43.00-$43.60)*500 shares - $4.95 commissions

Total Net Profit (If AMAT assigned at $43.00 at options expiration): +$520.05
= (+$775.00 options income +$50.00 dividend income -$304.95 capital appreciation)

Absolute Return (If AMAT assigned at $43.00 on August 25, 2017 expiration date): +2.5%
= +$520.05/$21,033.30
Annualized Return (If AMAT assigned at $43.00 on August 25th options expiration date): +100.3%
= (+$520.05/$21,033.30)*(365/9 days)

These returns will be achieved as long as the stock is above the $43.00 strike price at expiration.  If the stock declines below the strike price, the breakeven price of $41.95 ($43.60 -$1.55 -$.10) provides 3.8% downside protection below today's $43.60 purchase price.

Established Covered Calls Position in Kohl's Corporation

Today, a covered calls position was established in Kohl's Corporation (ticker symbol KSS) with a September 15, 2017 expiration.  Given the Covered Calls Advisor's current Neutral overall market outlook, an in-the-money covered calls position was established with the strike price of $35.00 moderately below the stock purchase price of $37.02. 

There is potential for a +3.0% absolute return in 30 days (equivalent to a +36.7% annualized return-on-investment).   This potential result substantially exceeds the Covered Calls Advisor's desired threshold of >20% annualized return-on-investment.  An upcoming ex-dividend of $.55 per share will occur on September 1st, so this dividend is included in the potential return-on-investment result detailed below.

The stock price of all big box retailers, including Kohl's, declined today in sympathy with the decline in Walmart stock after it reported decent (but not inspiring) quarterly earnings this morning.  The Covered Calls Advisor believes that Kohl's current valuation relative to its primary competitors is now very attractive:
       



Given this relatively attractive valuation along with Kohl's upcoming generous dividend and attractive options premiums (current implied volatility of 31.0), the Covered Calls Advisor decided to establish the Covered Calls position described below.  It is also noted that Kohl's already reported their earnings last week, so there will be no earnings report surprises prior to the options expiration date.





Kohl's Corporation (KSS) -- New Covered Calls Position
The transactions were as follows:
08/17/2017  Bought 500 Kohl's shares @ $37.02
08/17/2017 Sold 5 KSS Sept 15, 2017 $35.00 Call options @ $2.52
Note: this was a simultaneous buy/write transaction.
09/01/2017 $.55 ex-dividend

A possible overall performance result (including commissions) would be as follows:
Cost Basis Purchase of 500 shares KSS: $17,258.30
= ($37.02 -$2.52)*500 + $8.30 commissions

Net Profit:
(a) Options Income: +$1,260.00
= ($2.52*500 shares)
(b) Dividend Income: +$275.00
= $.55 per share x 500 shares
(c) Capital Appreciation (If KSS is above $35.00 strike price at Sept 15th expiration): -$1,014.95
= ($35.00-$37.02)*500 shares - $4.95 commissions

Total Net Profit (If KSS is above $35.00 strike price at Sept 15, 2017 options expiration): +$520.05
= (+$1,260.00 options income +$275.00 dividends -$1,014.95 capital appreciation)

Absolute Return: +3.0%
= +$520.05/$17,258.30
Annualized Return: +36.7%
= (+$520.05/$17,258.30)*(365/30 days)

The downside 'breakeven price' at expiration is at $33.95 ($37.02 - $2.52 -$.55), which is 8.3% below the current market price of $37.02. 

Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the Sept 15th, 2017 options expiration) for this Kohl's Corporation covered calls position is 70.6%, so the expected value annualized ROI of this investment (if held until expiration) is +25.9% (+36.7% * 70.6%), a very attractive result for this in-the-money covered calls position.

The 'crossover price' at expiration is $38.99 ($37.02 + $2.52 -$.55).  This is the price above which it would have been more profitable to simply buy-and-hold Kohl's stock until September 15th (the September monthly options expiration date) rather than establishing this covered calls position.

Friday, August 11, 2017

Established Covered Calls in Alibaba Group Holding Ltd.

Today, the Covered Calls Advisor established a new Covered Calls position in Alibaba Group Holding Ltd. (ticker symbol BABA) at the September 15, 2017 options expiration and at the $140.00 strike price.  This is the second BABA Covered Calls position now held in the Covered Calls Advisor Portfolio.  The first position was at the same strike price but was for the August 18th options expiration.  This new position is a relatively conservative one since it was established today when the price of Alibaba was $147.68 (5.2% downside protection to the strike price) and 36 calendar days remaining until the options expiration date.

For Alibaba, the chart below (click on the chart to view a larger and more legible version) shows that the potential annualized return of +31.9% for the Covered Calls position is preferable to the +30.4% to establish a comparable 100% Cash-Secured Puts position. 

This potential annualized return-on-investment of +31.9% exceeds the Covered Calls Advisor's desired threshold of >20%. 

The implied volatility of the Call options was 40.2 when this position was established, the highest it has been for Albaba options in more than a year.  This high volatility is largely attributable to the uncertainty associated with the upcoming quarterly earnings report due on August 17th as well as a rapid $10 decline in the stock price this week.  

The downside 'breakeven price' at expiration is at $135.70 ($147.68 - $11.98), which is 8.1% below the current market price of $147.68.  

Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing Calculator, the probability of making a profit (if held until the September 15th, 2017 options expiration) for this position is 69.5%. This compares with a probability of profit of 50.2% for a buy-and-hold of this Alibaba stock over the same time period. Using this probability of profit of 69.5% the expected value for the annualized return-on-investment (if held until expiration) is +22.2% (+31.9% maximum potential annualized return on investment * 69.5%), an attractive risk/reward profile for this conservative investment.  

Finally, the 'crossover price' at expiration is $159.66 ($147.68 + $11.98).  This is the price above which it would have been more profitable to simply buy-and-hold Alibaba stock until the September 15th options expiration date rather than establishing this Covered Calls position.

Thursday, August 10, 2017

Established Covered Calls in Bank of America and Delta Air Lines

Today, two covered calls positions were established in Bank of America (BAC) and Delta Air Lines (DAL) for the September 15, 2017 options expiration date.  Given the Covered Calls Advisor's current cautious overall market outlook, moderately in-the-money covered calls positions were established in each instance. Also, there are upcoming ex-dividend dates prior to options expiration which are taken into consideration for each of these two positions.

Some potential return-on-investment results for each position are: 
  • Bank of America Corp. -- A +1.3% absolute return in 37 days (equivalent to a +13.2% annualized return-on-investment if assigned at expiration; or a +0.8% absolute return in 19 days (equivalent to a +15.2% annualized return if assigned the day prior to the August 30th ex-dividend date).    
  • Delta Air Lines Inc. -- A +2.3% absolute return in 37 days (equivalent to a +21.9% annualized return-on-investment if assigned at expiration); or a +1.6% absolute return in 11 days (equivalent to a +52.3% annualized return if assigned the day prior to the August 21st ex-dividend date).
Details for the Delta Air Lines position are provided below to explain the position further for those interested in understanding the type of thought processes and calculations underlying establishing these covered calls positions.
 
Delta Air Lines Inc. (DAL) -- New Covered Calls Position
First and foremost, is is essential to invest only in companies that you are bullish about.  Delta meets the Covered Calls Advisor's key quality, value, and growth metrics.  My bullish sentiment is shared by respected analysts including: (1) Outperform by both Schwab Equity Ratings and Reuters Research Average Rating; (2) Buy by Argus (their highest rating); (3) Strong Buy by S&P (their highest rating); (4) Barron's article last weekend on Delta was bullish, indicating a +35% stock price potential sometime during the next two years; and (5) Just today, Barclays initiated a 12-month Overweight target of $70 (See link).  Also, as shown below, the potential rate-of-return exceeds the Covered Calls Advisor's desired threshold of +20% annualized return if assigned at expiration.  Another positive occurred yesterday when the Board authorized a substantial increase in the quarterly dividend from $.2025 to $.305 and DAL stock will go ex-dividend on August 21st, before the September 15th options expiration date for this Covered Calls position.

Because of Put/Call parity, Covered Calls and Cash-Secured Puts are synthetically equivalent strategies (when done at the same strike price for the same expiration date).  However, subtle and temporary differences often exist, so just prior to executing the transactions, a comparison is made to see which strategy provides a better potential return.  For Delta, the chart below shows that the potential annualized return of +21.9% for the Covered Calls position is preferable to the +20.6% for a 100% Cash-Secured Puts position in this instance:
 

You will notice in the chart above (click on chart to view a larger and more legible version) that there is a column titled "Intervening Earnings" and "NO*" with an indication that "If 'YES' then consider avoiding position".  The "NO" in this case means that Delta does not have a quarterly earnings report prior to the options expiration.

Also in the chart above is a column called "Intervening Ex-Div" and "YES" with an indication that "If 'YES' then complete Dividend Capture Strategy spreadsheet".  This means that Delta will go ex-dividend sometime between today and the options expiration date and the Covered Calls Advisor's Dividend Capture Strategy spreadsheet should be completed to assess whether the pre-determined criteria are met to justify establishing a covered calls position for Delta.  The Covered Calls Advisor has established a set of eleven criteria to evaluate potential covered calls using a dividend capture strategy.  The minimum threshold desired to establish a position is that at least nine of these eleven criteria must be achieved.  As shown in the table below, all eleven criteria are achieved for this Delta Air Lines Inc. position.


The transactions were as follows:
08/10/2017  Bought 1,000 Delta Air Lines Inc. shares @ $49.45
08/10/2017 Sold 10 DAL Sept 15, 2017 $48.00 Call options @ $2.20
Note: this was a simultaneous buy/write transaction.
08/30/2017 $.305 ex-dividend

A possible overall performance result (including commissions) would be as follows:
Cost Basis Purchase of 1,000 shares DAL: $47,239.88
= ($49.45 -$2.20)*1,000 + $11.65 commissions

Net Profit:
(a) Options Income: +$2,200.00
= ($2.20*1,000 shares)
(b) Dividend Income: +$305.00
= $.305 per share x 1,000 shares
(c) Capital Appreciation (If DAL is above $48.00 strike price at Sep 15th expiration): -$1,454.95
= ($48.00-$49.45)*1,000 shares - $4.95 commissions

Total Net Profit (If DAL is above $48.00 strike price at Sep 15, 2017 options expiration): +$1,050.05
= (+$2,200.00 options income +$305.00 dividends -$1,454.95 capital appreciation)

Absolute Return: +2.3%
= +$1,080.05/$47,239.88
Annualized Return: +21.9%
= (+$1,080.05/$47,239.88)*(365/37 days)

The downside 'breakeven price' at expiration is at $46.945 ($49.45 - $2.20 -$.305), which is 5.1% below the current market price of $49.45. 

Using the Black-Scholes Options Pricing Model, the probability of making a profit (if held until the Sep 15th, 2017 options expiration) for this Delta Air Lines covered calls position is 70.1%, so the expected value annualized ROI of this investment (if held until expiration) is +15.8% (+22.6% * 70.1%), an attractive result for this moderately in-the-money covered calls position.

The 'crossover price' at expiration is $51.345 ($49.45 + $2.20 -$.305).  This is the price above which it would have been more profitable to simply buy-and-hold Delta Air Lines stock until September 15th (the September monthly options expiration date) rather than establishing this covered calls position.