The Stock Option Writer
© Warren Kaplan 2011-2012
July 31, 2012
With the stock market bounding ahead in the last few days, it is time to review your portfolio and to sell covered calls. You can sell out of the money calls (strike prices at a higher level than the current price) and thereby continue to participate in a bullish market or you can sell covered calls at slightly below current prices and protect your profits and yet receive a total return that exceeds today’s current price.
General Electric (GE) is one of my favorite stocks. The share price reached $21.00 last week, equaling a 52-week high. It closed at $20.92 on Friday.
You can sell the GE August call at $21 and take in $.31. The expiration is just 3 weeks away. The $.31 adds 1.48% to the $21 price. If on August 17, the stock price closes at $21.01 or more, the shares will be called away except in a certain extreme circumstance. In effect, you will have sold the GE shares for $21.31. The $.31 affords you a small matter of protection from a decline, namely, down to $20.69. Once below that mark, it would have paid for you to have sold the stock at $21.00 and have looked to buy it back at a lower price. I think the stock price will back off so let’s look now at the Sept. $21.00 strike price. The sale of the Sept. 21 call will bring you $.55. This is $.24 more than what the August $21.00 call would bring. In other words, you are being paid at an annual rate of $13.7% for giving the option buyer another month ($.55-$.31). Also, you improved your downside protection to $20.45 and in effect you would have a sale at $21.55 if the shares are called away from you.
If you think the stock will bust through the 52-week high of $21.00 or if you have say 10 or 11 months of holding the stock and you want to stretch it out to 12-months for tax purposes, you can sell the August $22.00 call for $.05 or the Sept. $22.00 call for $.18. Keep in mind that the stock will go ex-dividend sometime around Sept. 21st. If the option buyer does not exercise their right to buy GE from you at $22, then you will get the expected $.17 quarterly dividend. You will also be in a position to sell another call and to rake in still more money. GE options trade with a high frequency making them very liquid. The October options, which expire on October 20th, bring just $.32 because the assumption is that you will get the September dividend. Also, it must be noted that when a stock goes ex-dividend, the market price of the stock goes down that amount.
Keep in mind that the strike price of $22.00 is 4.55% higher than $21.00 and your potential return is that much greater. Annualized, it translates into a 54.55% additional gain. However, that amount of return should not be expected on a consistent basis. Obviously, the higher the strike price, the less premium you will receive. Hence, the less price protection you have. If you are not concerned about price protection, you should consider the December $25 strike price. The premium is only $.05 but look at the potential additional gain namely $4.00 from $21.00. You will probably pick up an extra $.34 in dividends. The option period ends after USA elections and regardless of ho wins, the unknown factor becomes known. So just consider the $.05 ($5.00 per 100 shares) as a “tip”. A more protective posture would be to sell the Sept. $20 call and take in $1.20. It is like selling the stock at $21.20 in 8 weeks. You would not get the dividend if it got called away but conversely, if the stock drops back below $20, you would have gained the $1.20 and still have the stock and you would get the $.17 dividend after it went ex-dividend. The October $20 strike price brings $1.35 in premium to you, which you get immediately. In effect, you sold the shares for $21.35 and you will get the $.17 dividend for a total of $21.52.
The bad thing is as an option writer; you are locked in for 4.75 months for a nickel. Of course, you can always buy back the option and close that position but 5¢ does not leave you much room and commissions can just chew you up. Remember that as a writer, you want to write an option in as short a time period as possible.
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.