The Stock Option Writer
© Warren Kaplan 2011-2012
September 26, 2012
Although the market averages have not drifted down the way I expected, if you wrote puts at lower levels, you did not get put (assigned) this past weekend and once again, you have available cash. In the case of the ETF XLU, (Utilities Select Sector of the S&P), you saved money by not buying the stock and just writing put options at lower prices. If you were already long and if you wrote covered calls, obviously, you were not called and you received the benefit of taking in more money on top of the dividend. The stock went ex-dividend $.3812 on Sept. 21 and you will receive the funds on Oct 3rd. Based on the Friday Sept. 21 closing price of $36.03, your dividend yield is 3.98%.
The index includes companies from the following industries electric utilities; multi-utilities; independent power producers & energy traders; and gas utilities. All of the companies are listed in the S&P 500.
The way I read the charts, I think the stock could decline to the $35.00 area. So you might consider putting in a put to sell at $35 or even $34 asking for a larger premium than what is currently available. For example, the Jan 2013 put at $35 will bring you $.77. Of the stock declines from $36.03 to $35.00 in a short period of time, you should receive approximately $.97. If the stock drops below $35.00, then the premium you would get would be boosted by the exact decline of the stock. So, if the stock drops to $34.75, you should be getting about $1.23. That would give you an annualized return of 10.93%. Your cost, if you were put at $35.00 is really $33.77. You simply divide the $1.23 by $33.77 times the answer by 3. Why 3? Because there are 4 months from now to January 2013 and 12-months makes a year.
If you are long XLU, you should have a sell price in mind. I always have a sell price in mind as soon as I acquire or even if I may acquire a stock. And, the sell price should be paired with a time factor. If you picked a stock like GE, you should estimate what you think the dividend will be in a certain period of time. So, when and if the dividend of say GE equals the payout it had in 2008, it would be a fair assumption to think that the stock would sell at that level again. If that takes another 5 years, then GE shouldn’t see $30 for 5-years. So, you have to ask yourself if that would satisfy your investment strategy. If so, then why not sell covered calls at $30 now that expire in January 2013 or 2014? For January 2013, you could get 1¢, for March 2013 you can get 3¢ and for Jan 2014, you can get $.21.
Meanwhile, your XLU selling price is something that you need to decide. If you have money manager, you can discuss that with them. If not, then you have to decide. Say you paid $36. Why not sell the $40 call? The Jan 2013 call would bring 1¢ and if exercised, a gain of $4 a share for a healthy gain of 11.11% in just 4 months. The annual gain would be 33.33% and you would receive a dividend in December. The March 2013 $40 call would bring you about 3¢. If the stock I below $40, you would receive not only the December 2012 dividend and the March 2013 dividend. If it were called away, your $4 capital gain would equal an annualized yield of 22.22%. The January 2014 $40 call would bring you $.45 as well dividends for December, March, June, and September and December. The $4 capital gain yields you 7.8% annualized. There are 17 months to go till your obligation ends in January 2014. The dividends add another 3.9%.
So, you see, you can use option writing to enhance your return. What I like about the ETFs is that you do not have to rely on one single stock. There is always the risk that the accounting gets challenged or that someone in management screws up. I remember when GE was cited for price fixing with Westinghouse. The stock was punished and the company was eventually fined. In other words, all companies are a risk so in this case, using an ETF gives you a large measure of protection. Conversely, don’t expect home runs with an ETF. The idea is not to get wiped out and not to worry when the market will swoon. In fact, swoons are opportunities. One long-term swoon is the XLF, which I have written about under the belief that not all financial companies are going to disappear at the same time. Will the XLU be affected by higher interest rates? Maybe. But that would be because when interest rates rise, people will be able to sell their utility stocks and seek yields somewhere else. The stock market is a living “thing” and what I write about is ways to enhance income and frankly is a long-term point of view. The longer term that you write an option, the greater the risk. But then again, do not write a put unless you rally want to own the stock at a price certain. Do not write a call on a stock that you really would sell at that strike price.
Warren Kaplan has been writing options for 50 years. He has been a stockbroker, investment banker and brokerage owner. He currently owns and operates Kaplan Asset Management, a provider of financial assistance for small to middle market businesses. He has more than a half-century of experience in dealing with financial markets, giving guidance and consulting with management, and assisting in the development of business strategies and solutions. The Company has assisted and consulted many successful companies, such as Natures Bounty (NBTY) and Action Products International (APII), helping them to go public and trade on the NASDAQ stock exchange. His philosophy is to “do something with the profits.” “If you make $100 in the stock market, take 50 percent and invest it back into the market. Then, take the other 50 percent and buy yourself something.”
Reader’s comments are welcome. Please do not consider these opinions as advice and we take no responsibility for any trades made. You should review these option writing ideas with your financial advisor so that you are properly guided. Writing options is not for everyone. If you want information about a certain stock, please email email@example.com