Chasing Dividends with Covered Calls on SO

After my plan yesterday with PG deep in the money covered calls didn’t work I tried a slightly different approach with Southern Company (SO) today.  I decided to increase my risk slightly and not go as deep in the money with the covered calls today.  As a couple of commenters predicted my PG calls were so deep in the money that they became easy targets to get called away after the close yesterday.  After looking at the open interest on the PG calls and how it changed from yesterday’s close to this morning I saw that I needed to use a strike closer to the underlying stock’s current trading price.  The probability of having my shares called away (aka assigned) decreases the closer the strike is to the stock’s trading price, but each strike higher also increases the risk of the underlying stock dropping below the strike before I can get out with a profit.

After seeing that SO beat earnings estimates in today’s announcement and then charting SO I decided the downside risk wasn’t too big.  I bought 500 shares of SO at $35.25 and sold five SO May 33 covered calls at $2.23 each for a net debit of $33.02 per share or $16,516.07 with commissions.  Earnings should keep SO above $33 pretty easily, but you know I love a good chart too and I see strong support likely around $33.00.  I also see a good chance of support at $34.00, but with $16,500+ on the line I decided to manage my risk a little tighter, even if it means I sold the calls too deep in the money again and might get another option assignment before I can get the dividends.

This is the way I see this one working if I don’t get another option assignment before tomorrow’s open:

• Opened for a total of $16,516.07
• Dividend total should be $227.50
• Expect to close for $16,450.00
• -16,516.07+227.50+16,450.00 = $161.43
• 161.43/16,516.07 = 0.977%
• Annualized gain if I can repeat this monthly = 11.73%

I lowered my expectation of what I think I’ll be able to close the position for compared to what I was originally thinking yesterday.  What I missed at the beginning of yesterday’s process, but caught onto by the afternoon was that the extrinsic value (price of the option outside of the amount in the money) will increase after the dividend is paid.  With my math above I’m planning to close my position for $32.90 per share/contract.  That gives an increase of 12 cents for the extrinsic value over what I sold it for this morning.  The change in intrinsic value is moot because I’ll get an equal offsetting change in the stock price itself. 

If I hold the position for another three and a half weeks until expiration I’ll actually make more by not having any time value and not paying a commission (thanks IB) on option assignments.  The issue with waiting is that I’ll keep the risk of a dip in the shares falling below the strike.  From my current standpoint I’d rather close the position for a smaller profit than assume a greater risk.  Remember, this cash I’m using is sitting there backing my other naked put positions.

As John commented on yesterday’s post, he has tried this approach and had it work for him.  I’ll figure out the best balance of risk/reward before long and will be able to implement this on a regular basis eventually.  Stick with me and please keep providing feedback.  Yesterday’s comments were a big help for my learning curve.

I’ll add a comment here tomorrow morning when I know if I get another option assignment.