Friday, July 20, 2018

Mea culpa, mea culpa, mea maxima culpa.


Pardon the appearance of my website.  Normally I wouldn't send out a first post while the blog is under construction, but I'm such an IT Luddite that waiting to post until the site appearance is respectable might take forever & I'd never get to satisfy my objective of helping you with option selling.  Plus, since I do have a pretty good sense for conveying the nuances of this arcane strategy, I hope you find it's worth getting going now rather than waiting until my site is pretty.

And - please pardon me again, because this sounds quite self-serving - I do want to promote my 144 page, recently published primer Selling Options...Simply Called and Simply Put.  However, I don't even know how to link the "Buy Now" button.  I am confident though, that even if you have zero understanding of option trading, as long as you have a keen desire to learn the strategy, my crystal clear book will be most helpful.

In a future post, I'll tell you a bit about myself, including my experience with options.  But I'd like, with this post, to share with you a trade I recently made that very succinctly answers a question I'd received while in the investment business.  Clients asked, "When I sell covered calls, how frequently may I experience early assignments?"

I use monthly options which always expire at the close of business on the month's 3rd Friday.  But a pre-mature (as I like to describe them) assignment of a call can occur anytime prior to option expiration Friday.  Quite frankly, they usually do not occur pre-maturely.  But when they do, I find, it's generally when the underlying equity (stock) is a dividend paying equity, & the call option is in the money (the equity's market price is higher than the option's strike price).  And when that's the case, the pre-mature assignment of a call generally happens on the business day before the ex-dividend date.

So, my trade:  To start with, on May 21, 2018, I sold a covered call against TLT, the ticker symbol for the US Treasury ETF.  TLT was trading around $117.  I sold the June 15, 2018 call, with a $118.50 strike price, & received a $0.55 premium.  But on May 31, TLT traded at $121.  And I knew that on on June 1, TLT would go ex-dividend on its $0.28 monthly dividend.  I suspected that the owner of the TLT June $118.50 call (the owner would have bought the call some time earlier from a seller like me) might want to exercise that call to become the buyer of TLT at $118.50 & importantly, to be eligible to receive that $0.28 dividend.  But by exercising on June 1, he'd be a TLT buyer on the ex-div date, the "without" dividend date, & he'd not be eligible for the 28 cent div.  However, by exercising on May 31, he'd be buying TLT "with" dividend, & be eligible for the 28 cents.  To capture the dividend, I knew that he might be motivated to exercise his in the money call on May 31.

I did not like the prospect of being assigned to sell my TLT pre-maturely on May 31, at only $118.50 (my strike price), when TLT was trading in the market for $121.  So I used what I call a repair strategy (most option traders call it a roll out).  In step #1, I bought back the TLT June $118.50 call, which I had sold on May 21, but I had to pay a rich $2.89 premium on May 31.  This closed out (terminated) my June $118.50 call.  In step #2, I immediately sold a TLT July 20, 2018 call, with a $119 strike price, for a richer premium of $3.04.  I pocketed the 15 cents in premium difference, & now have the potential for another half dollar in strike price.  For extending my strategy one month, I accepted the potential for another $0.65, which annualizes to a 6.5% return versus the original $118.50 strike price.  Not too bad a repair of an unwanted obligation.

Keep in mind, with TLT at $121 on May 31, the day of my repair, the new $119 call is still in the money & I could certainly be assigned pre-maturely.  But if I was forced to sell my TLT quickly at $119, well in advance of July 20, my annualized return would then be enhanced above the 6.5% return.  And to be honest with you, the market is very smart, & it probably would not allow me to get such an enhanced return so easily.

I hope this kind of blog is helpful.  Let me know.  Ask me questions.

Dave Skonieczki   


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