The Stock Option Writer
© Warren Kaplan 2011-2012
October 2, 2012
This ETF has everything going for it regardless of election results, war, peace, taxes and deficits. At its current price of $40.12, the dividend yield is approximately 2.37% and the dividends have been growing year after year.
The top 10 stocks, in percentage order, in the ETF are Johnson & Johnson, Pfizer, Merck, Abbott Laboratories, Amgen, United Health Group, Bristol-Myers Squibb, Express Scripts Holding, Eli Lilly & Co, and Gilead Sciences. All of the funds holdings come from the S&P 500. The stock percentages are selected based on a market value basis.
This is a low risk fund. That is, you do not get fast wild swings in this stock. Hence option premiums are not percentage large like they would be in say Apple or Google or in certain pharmaceutical stocks. Remember that the idea of this article is to show you ways to reduce market risk and to increase income. Additionally, I can tell you that the best book I have ever read that pertains to the ETF SPDRS is Sam Stovall’s The Seven Rules Of Wall Street.
The current 52-week range is $30.111-$40.68 and back in 2008, the index had its worse 3-month price movement namely it went down 23.04% followed by its best 3-month upward movement of 15.12%.
Based on the way I see the charts, the stock could easily back off to $39 and still be in an upward trend. The stock goes ex-dividend around December 15. In an effort to buy the stock at a lower price than it is selling for today, you can write the Nov 17, 2012 put at $39.00 and receive a premium of $.37. That translates to an effective cost of $38.63 to you, which is the amount of money you need to put up in order to write the option. Remember to never write a put option unless you are really ready to own the stock at that level. Your annual dividend yield would be 2.46%. Of course, once you own the stock, you can turn around and sell a covered call at say $40 or $41 for January 2013. That premium currently is $1.22 for $40 and $.72 for $41 would reduce your outlay and thereby increase your annual dividend yield. If the stock rises and your shares are called away, you will have a capital gain of 2.56% at $40 or 5.13% at $41.
You could consider a longer-term option on the stock because of the dividend and couple that with a higher strike price. In checking the current Jan. 2014 options (a mere 15-months away), I noted that the $40 call option would pay you $2.81, which is far more than the current annual dividend of $.9511. Now, here is the beauty of writing that option: if you went long the stock at the current price of $40.12, you would receive $2.81, which means you would only have to put up $37.31 and you would get at least one year of cash dividends. If the stock gets called before January 2014, your obligation ends and you keep the entire premium. Since I am bullish on the longer term as to health care and the stock market, I checked the 2014 $45 strike price and saw that if you write that option, you will receive $.74 as well as the cash dividends for all of 2013. If the stock gets called away, your obligation ends and you will have received $45 a share for those shares that you paid $40.12 each plus the dividends. Here again, your cash layout is reduced by the premium you received so you only need to put up only $39.38.
Another strategy is to write the January 2014 $38 put. That option currently pays $2.96. That would reduce your cash outlay to $35.04. If you don’t get put at $38, then you earned 6.76% instead of 2.37% and you took less risk as to principal. Obviously, the more risk you are willing to take on, the greater the potential return. You just have to decide what price you would be willing to own the stock. Based on history, there is an excellent chance that the ETF will payout more in dividends in 2013 than in 2012 and I would expect that 2014 will have higher dividends than 2013. The best use of writing options is to try to establish stock positions at levels that make you comfortable.
Currently, the longest-term option of the XLV ends in Jan 2014. The exchange does have longer-term options on select issues such as IBM and INTC. They expire in January 2015.
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 firstname.lastname@example.org.