Thursday, September 1, 2016

Options in Reverse

  In May 2015 I wrote about my adventures in selling covered call options from the self-directed Fidelity brokerage account that I transferred my 401k balances from past jobs into. Most of my stock activity concerns Intel (INTC) which I buy when the price goes down and sell when the price goes up enough to get my investment back and keep 5 shares of the stock as a bonus. In addition to accumulating shares in this piecemeal fashion I’ve had Fidelity use the Intel dividends (26 cents per share per quarter) I receive to buy more shares of the stock commission-free which is a nice bonus. In addition to owning the shares of Intel, I’ve been generating extra cash by selling options to purchase my ‘bonus shares’. The options I’ve sold are for a purchase price high enough to guarantee me a profit and far enough in the future (two to six months) to provide a nice ‘rental fee’. On most occasions, the option expires without being exercised and I keep the stock and the money also. A few times Intel’s price jumped before the option expiration date and I had to sell the shares at a considerable discount to the current price. Not making as much money as I could have with perfect timing has never been a concern for me and I’ve always been able to replace my ‘bonus shares’ at a lower price than I sold them for by being patient enough to let the stock market do it’s up and down thing.

  In my post from last year I wrote about my other two favorite option stocks – Emerson Electric (EMR) and Exxon (XOM). Exxon is a well-known company that has raised its dividend every year for over 30 years. I learned about Emerson when I was a consultant at their Fisher Controls division in Marshalltown. The bottom line is all important to Emerson. They close plants that aren’t making enough money and offer retirement packages to get long time employees off the payroll with the implied threat of being laid off with no package if the companies’ overtures are rebuffed too many times. Emerson has increased their dividend for 59 consecutive years although the increases are not as large as Exxon’s.

  Both Emerson and Exxon are sensitive to the price of oil. With the price of oil being so low I was unable to sell options in Exxon and Emerson at a high enough price to guarantee me a profit for the stock from June of last year to March of this year. It wasn’t a complete loss as both companies provided a dividend of over 3% (which I reinvested in their company’s stock commission free) while I waited for the prices to rebound which they did in March. Now that both stocks have rebounded somewhat I am back to selling covered call options but with a new twist that I learned last year – buying the options back.

  On 5/13/2015 I sold a covered call option to sell 100 shares of Emerson at $62.5 on 6/19/2015 and pocketed $57 ($65 less $8 commission). The stock was trading for $60 at the time. Between June 3rd and June 5th Emerson stock dropped from 60.30 to 58.50. The same option I sold for $65 was now selling for $15. I called Fidelity and found I could buy a covered call option and cancel the obligation I took on when I sold the option. I bought the covered call option for $22.99 ($15+$7.99 commission) and had the stock and $34 profit. I immediately sold another option to sell Emerson for $60 expiring July 17th and received another $107. By June 23rd the Emerson stock price was unchanged ($58.35) and I bought back my option at the reduced price of $32.99 including commission. This cleared me another $74 for a total of $108 or 1.76% on my investment in 40 days and I still owned the stock!

  Buying back options with Emerson was a real eye-opener. One thing I could have done better was perhaps not even buying the options back or waiting until the price of the options fell further. Last fall Fidelity made it easier to buy options back by making them commission free for a price of 10 cents or less which makes me want to wait until the option price goes to 10 cents before I buy them back.

  I would like to say my Emerson adventures have been a success but the truth is that even though I’ve collected $350 in options and $330 in dividends since December of 2014 I am still showing a loss for the 20 months I’ve owned this stock. I’m not especially concerned since I’m in for the long haul and collecting the occasional option boost in addition to the regular dividend continually lowers my beak even point so when the next wave of enthusiasm washes over Emerson I’ll collect a profit on the stock and keep the options and dividend cash as an extra bonus.
  
12/10/2014Buy 100 EMR @ 61.444-6152.35
12/18/2014Sell 1 EMR Option @62.5 (.95)
Expiring 1/27/2015 (not exercised)
+87.01
3/11/2015Dividend EMR (Payable 3/10/2015)+47.00
5/13/2015Dividend EMR (Payable 6/11/2015)+47.00
5/14/2015Sell 1 EMR Option @62.5 (.65)
Expiring 6/19/2015
+57.00
5/14/2015BUY EMR Option @62.5 (.15)
Expiring 6/5/2015
-22.99
6/5/2015Sell 1 EMR Option @60 (1.15)
Expiring 7/17/2015
+107.00
6/23/2015BUY EMR Option @60 (.25)
Expiring 7/17/2015
-32.99
8/11/2015Dividend EMR (Payable 9/10/2015) +47.00
11/10/2015Dividend EMR (Payable 12/10/2015)+47.50
2/10/2016Dividend EMR (Payable 3/12/2016)+47.50
3/17/2016Sell 1 EMR Option @60 (1.05)
Expiring 9/16/2016
+97.00
5/11/2016Dividend EMR (Payable 6/10/2016)+47.50
6/24/2016BUY EMR Option @60 (.10)
Expiring 7/17/2015
-10.04
8/10/2016Dividend EMR (Payable 9/9/2016)+47.50
8/17/2016Sell 1 EMR Option @60 (.75)
Expiring 1/20/2017
+67.00
Total-5472.36
Total if sold at 8/29 price of 53.73-104.33-1.70%
Total if 1/20/2017 option is exercised+551.56+8.97%


  I’ve had much better luck with Exxon. I dipped back into selling Exxon options in February when I made $76 on an option to sell 100 shares at $90 on July 21st. At that time the stock was $80.67. Exxon hovered around $90 in April and May and made a big move in July, reaching $95 a share in the week before my option was exercised. I felt a little stupid selling a $95 stock for $90 but I was following my plan of accumulating small gains at a low risk. All told my 21 month investment in Exxon netted me a 3% profit which worked out to be 1.6% annually which while not a great return certainly beats a loss.

  That would be an acceptable outcome but my Exxon story is still incomplete. Once my option was exercised on July 21st at the $90 price, Exxon plummeted and just 10 days later I was able to buy the same 100 shares for $87.46. I immediately sold another option to sell these 100 shares for $90 on October 21st which put $133 directly in my pocket and 10 days later XOM declared a dividend of .75 cents which will give me another $75. If the option is exercised in October my net Exxon investment will have a total 7.5% yield or 3.6% annually. Not a bad increase for 10 days after selling the stock at a reduced price.

  
9/24/2014Buy 100 XOM @ 95-9507.95
10/9/2014Sell 1 XOM Option @97 (.50)
Expiring 10/31/14 (not exercised)
+42.01
11/7/2014Sell 1 XOM Option @99 (.39)
Expiring 11/22/14 (not exercised)
+31.01
11/11/2014Dividend XOM (Payable 12/10/2014)+69.00
12/19/2014Sell 1 XOM Option @95 (1.25)
Expiring 1/17/2015 (not exercised)
+117.01
1/21/2015Sell 1 XOM Option @95 (.47)
Expiring 2/06/2015 (not exercised)
39.01
2/13/2015Sell 1 XOM Option @95 (.75)
Expiring 3/13/2015 (not exercised)
+67.00
3/10/2015Dividend XOM (Payable 3/11/2015)+69.00
5/10/2015Dividend XOM (Payable 6/10/2015)+73.00
8/10/2015Dividend XOM (Payable 9/10/2015)+73.00
11/10/2015Dividend XOM (Payable 12/10/2015)+73.00
2/3/2016Sell 1 XOM Option @90 (.84)
Expiring 7/15/2016
+76.00
2/9/2016Dividend XOM (Payable 3/10/2016)+73.00
7/21/2014Sell 100 XOM @90
Exercised Option
8991.85
8/1/2016Buy 100 XOM @87.465-8754.45
8/1/2016Sell 1 XOM Option @90 (1.33)
Expiring 10/21/2016
+125.00
8/10/2016Dividend XOM (Payable 9/9/2016)+75.00
Total-8268.51
Total if sold at 8/29 price of 87.84+499.49+5.25%
Total if 10/21/2016 option is exercised+715.49+7.53%

  When Exxon leaped to $95 in July I noticed something strange in the prices of the short term options. When the stock was priced between $91 and $92 the option to sell covered calls at $90 on July 21st was between $2.5 and $3 a share. This meant I could buy 100 shares at $91, collect $250 to sell the shares at $90, and if the price stayed above $90 for two weeks could collect around $125 in profit when the option was exercised ($250 option profit - $100 stock loss - $25 commissions). Normally I see short-term options for a stock at or over the current trading price trading very close to the difference between the two prices (an option to sell a stock trading at $90 for $91 in the future generally trades very close to $1). This large gap seems like an anomaly.

  I looked for this pattern in other stocks and while it is a rare occurrence it does occur. The only downside I could see is that if the price of the stock plummets the option wouldn’t be exercised and I’d be holding a loser stock. I didn’t consider that much of a downside as long as I did this with top quality stocks with a history of paying dividends so I would get some return on a dormant investment until a wave of enthusiasm lifts the stock price yet again.

  I had a chance to pull the trigger on this with Exxon but couldn’t bring myself to do it. I was kicking myself for leaving easy money on the table when I noticed an exceptionally high price on Apple (AAPL) options and decided to dip my toe in the water. On July 18th I bought 100 shares of Apple at $99.61 and immediately sold the option to sell the stock for $100 on August 19th. The option gave me $199 and I was counting on a $57 dividend that Apple was issuing on August 4th to further boost my return. A week later Apple’s stock price dropped to $96.82 but jumped to $104 the next day on Apple's announcement that their 'app' store had record revenue for the quarter. The stock stayed over $104 and on August 4th my option was exercised and I sold the shares for $100. The good news was that I collected $221 in 17 days for a 2.2% return (47% annual). The bad news was that the option was picked up early in order for the buyer to collect the dividend instead of me. But don’t cry for me – I’m happy to have picked up a reasonable profit with little to no risk.

  
7/18/2016Buy 100 AAPL @99.61-9969.45
7/18/2016Sell 1 AAPL Option @100 (2.08)
Expiring 8/19/2016
+199.25
8/4/2014Sell 100 AAPL @100
Exercised Option
9991.83
Total+221.63+2.22%

  I made a bolder excursion into options two weeks ago when I noticed this same pattern in my favorite stock, Intel. Intel has been trading at multiple year highs in the last two months, hovering between $33 and $35 a share and I’ve been doing very little with the stock except to sell shares I previously purchased and keeping ‘bonus shares’ as my profit. On August 19th I bought 200 shares of Intel for $35.07 and immediately sold an option to sell the shares on October 21st at $34 a share (a guaranteed $1.07 a share loss). Why would I offer to sell stock I just bought at a loss? Because I collected $1.89 a share to sell the options and selling the stock at a loss on October 21st would give me a profit of $137 or 2% of my total investment.

  To some, a perfect scenario would have the price of Intel drop to $33.99 on October 21st so my option won’t get exercised and I can sell another option. I’m hoping that the price in Intel will stay above $34 so the option will get exercised. I’m not looking to make huge killings with this ‘new toy’ I’ve found – I’m trying to grab a quick percentage point or two in as low-risk a way as possible. I've talked to a number of people about this strategy with the opinions ranging from brilliance to idiocy. I believe the truth is as always somewhere in between but we'll all have a more informed opinion on October 21st.