I’m trying something new today. Before I made this trade I asked a reader who I exchange ideas with sometimes what he thought of this approach. He said he’s tried it and it didn’t work for him, so I don’t recommend following my lead yet until I can see if I can get it to work for me.
I’ve been looking for somewhere to put my cash reserves to work while it sits idle waiting for an option assignment. Since this rally has been running for so long I haven’t had many put assignments and haven’t needed the cash to back me up. Knowing that can change at any time I want to have my cash available in a very low risk, low volatile position. I used to use PVI, but the yield got too low for me (below 1%) to consider it worth using still. Since I started using more dividend stocks with covered calls in my IRA I’ve enjoyed getting the dividends on top of my premiums and that got me thinking. What if I bought a stock before its ex-dividend date and also sold deep in the money covered calls on it to protect my downside. I’ve found a few worth trying that offered at least a 3% dividend and were not very volatile. I’m starting with Procter & Gamble Co. (PG).
This morning I bought 300 shares of PG for $63.55 per share and sold three PG May 55 covered calls for $8.53 per contract which cost me $16,509.64 after commissions. I entered the order as a buy/write yesterday for $54.95 and had to up it this morning to $55.02 to get it to hit. If I hold the position all of the way to May options expiration I’ll close the position by taking a $9.63 loss on the shares with commission, but will have pocketed $144.75 in dividends. That should give me a return of 0.818%. It’s tiny, but that’s over four weeks. If I can do that once a month with a different stock each time it would annualize out to 9.82%. PG’s ex-dividend date is tomorrow, April 28th, so I can close the position later this week and work on another stock with the same strategy. Of course by closing the position early I’ll incur more commission charges and almost certainly will have to below a buy/write cost of $55.00. That will reduce my return, but will give me the opportunity to use the money elsewhere. While I’ll make less, I’ll reduce my risk of something bad happening to PG and falling below my strike.
Since this is my first time trying this and was told that it doesn’t work I only used 300 shares in my test. Worst case PG tanks this week and I end up buying 300 shares. I wouldn’t mind owning it with a cost of $55.02. If it works I’ll up my exposure a little bit more next time and will be on the hunt for new stocks with ex-dividend dates coming up. On my radar next is Southern Company (SO). It’s yielding 5.2% and has an ex-dividend date of April 29th. JNK is volatile, but has an 11.76% yield. It’s ex-date is the 1st of every month.
Has anyone else tried this with any success?
I haven’t tried this, but I would think that with so little time premium on the options you’re at considerable risk of the options being assigned prior to tomorrow’s ex-div date.
I agree. The 300 shares will probably be called away today and you’ll be out a couple of cents per share. However, it’s possible that the holder of the Call Option may make a mistake and your shares won’t be called away.
Personally, I’m in the process of re-organising my portfolio into a lower-risk portfolio. Basically, I’m moving from the likes of JCI and SKX to PG and MCD.
With PG, I bought a couple of hundred shares at $63.38 in early March and they’re trading at exactly the same price today. However, at the same time, I sold 2 July 65 Puts and 2 July 65 Calls at the same time. At the moment, $110 of time value has been sucked out of the Calls and $130 has been sucked out of the Puts. Therefore, I’m still in a relatively comfortable position.
Just as a side note, when I made the PG trade, I purchased 200 MCD at $63.41 and sold Jun 65 Puts and Calls. MCD is now trading at $70.99 and the 65 Calls are trading at $6.20.
As there is only $0.21 time Premium left in the Options and the dividend is more than double this, I’m expecting MCD to be called away from me when it goes ex-dividend in early June. I’m hoping for either a small pull-back or a mistake by the Call holder though.
You two could be right. I might have gone too deep in the money on the first try. So, worst case I lose $9.63 for trying. I’ll try SO tomorrow, but closer to the money. So far from what I can see on my screen at 3:15pm, my 3 calls were the only ones to trade at the 55 strike today and there are 392 contracts listed for open interest. I’ll check open interest tomorrow again out of curiosity to see if it has a big drop. Either I found a sucker or I’ll start over with a different aproach.
The 57.50 strike has traded 10 contracts today and the 60 strike has traded over 24k. I think the 60 strike would have been safe, but I want to see how the option prices change after dividends are paid. The option price might not drop as deep as the stock does which could force me to hold for longer and that’s where the real risk is in my opinion.
Interesting – I hit refresh on the options screen for PG right before I posted this comment and 8,000 more contracts traded hands at the 55 strike. 4,000 more hit at the 57.50 strike.
The option prices should already reflect the ex-div stock price, so I wouldn’t expect any significant effect on option prices from that alone.
@ R Pell – As of my trade this morning there was $0.02 worth of extrinsic value in this option. You are saying you don’t expect that to increase after the dividend is off the table? I could see the call options being priced lower until tomorrow because of the expected drop in price coming.
I’ll add a comment here in the morning once I know if I’ve had an option assignment on PG.
I’d expect the extrinsic value of the option to increase (and intrinsic value to decrease) as a consequence of the underlying stock going ex-div and the option price staying the same. (Of course I’m only referring to the effects from the stock going ex-dividend alone – there will always be other factors at work affecting the stock and option prices at any given time.)
Yep, we’re saying the same thing then.
Well, that didn’t work. This morning (4/28) I received notice of my option assignment on PG. My shares were called away before the open so I won’t receive the dividends. I’m going to try again on Southern Company (SO) today, but not as deep in the money to see if that makes a difference.
As an update to open interest from the fourth comment above, the 55 strike went down to 2 contracts left open from 392 at the close, the 57.50 strike went down to 10 at the open from 205 at the close, the 60 strike went down to 2,318 open from 4,014 at the close and the 62.50 strike stayed the same.
Apparently to make this type of trade work I’d have to take more risk, closer to the money or have some luck to be one of the few contracts left if I’m farther out of the money.
I’ve tried it, and it works, but I don’t tie up as much capital in the process. I will use a more volatile stock, one with a negative skew, so that the bias is to the downside. Secondly, if you use this strategy enough, you will find many arbitrage opportunities (selling more overpriced calls vs their put counterparts) so that your average return will be closer to 1.5% or more (rather than your <1% example).
Thanks John. Can you give us an example of one of your trades like this the next time you work one? I’m writing up my SO trade details from today (4/28) now and will have it posted before long.
You paid $55.02 for a stock that was almost a certainty to be called away from you for the divvy (as it was). If the extrinsic value in a short call is less than the upcoming divvy, you should assume that it would be exercised the day before ex-div (you have to get pretty lucky to have it go unexercised.
I use a similar methodology to what you are attempting but either go out another month for the short call portion so that the chances improve that the extrinsic value is greater than the divvy (so I get to be paid the divvy), or sell naked the DOTM put which already reflects the fact that the stock will be paying the divvy and providses the same downside protection as the CC.
@ Ken – I think going another month out might be the key, but there’s not much extrinsic value in those calls either, except at-the-money which seems too risky. I’ll probably give it a try though.
Selling deep out of the money naked puts isn’t as alluring to me since there’s no dividend. I’d prefer to sell them closer to at-the-money or one strike lower like most of my trades.
Alex:
Keep in mind something called put/call parity. The price of the put/call options at the same strike typically takes into account any divvy that may be paid during the cycle [as well as risk-free interest rates which today are basically 0%]. If this were not the case than an arbitrage could be set up to take advantage of any disparity and then the disparity would quickly disappear as prices get pushed into parity again.
Right now @ 355PM, SO (the other stock you were doing this strategy with)is at 35.29 and the May 33 puts are .05X.15. If you sold it at midpoint (.10), your naked yield would be about .3% (assuming you fully cash secure the naked put, significantly higher yield if done on margin) for an annualized [approx] 4.5% which does not equal SO’s divvy yield, but a whole lot better than cash with considerable downside protection.
No free lunches unfortunately. I wish there were I would be headed for the front of that line.
Good explaination Ken. I understood the parity going in, but misjudged how deep the calls could be before they’d all get cleaned out. Attempting the 55 strike was just silly (to use a nice word), but at the 60 strike I had slightly better than a 50/50 chance of it working based on what the open interest was before the markets opened. The 62.50 strike looks like it would’ve worked. So, what I have to decide is how much risk I want to take if I’m going to attempt this any more. The 33 strike on SO might have been $1 too low to not get assigned. I’ll know in the morning.