Sunday, April 23, 2017

Covered calls a 2 edged sword GILD, KSS, MSFT, LLY

Selling covered calls is a frequently used technique to boost income.  I am not talking about trading options.  Trading options is a totally different animal.  Selling covered calls delivers additional income.  When you use them on stocks that already pay a dividend, your income can benefit from both dividends and call premiums.  However, no strategy is perfect including selling covered calls on dividend stocks.  In this post I review 4 calls that just expired (4/21/2017) and review how these can be a two edged sword

  • Selling covered calls on dividend stocks can boost your income.
  • Calls that are assigned (called away) where the call buyer executes their option to buy your stock can rob you of upside potential.  - Lost Opportunity
  • Calls with expiration dates after bad news can saddle you with a stock whose price is deteriorating and you are stuck with it. - Downside Risk

The four calls I am writing about today are Microsoft, MSFT, $65, Eli Lilly, LLY, $80, Kohl's, KSS, $47.50, and Gilead, GILD, $77.50.  All expiration dates were 4/21/2017. 
MSFT and LLY calls were assigned.   The KSS and GILD calls expired.  Let's see how we did.

Microsoft $65 4/21/2017 - An example of how calls should work

I am using one lot of MSFT for this explanation.  I bought this 100 shares on February 23, 2016 at $51.25.  The next day I sold a May 20, 2016 $55 call for a premium of $1.00.   Microsoft is tricky because their ex-dividend date tends to fall on the day before some call expiration dates.  I have had MSFT called early by a very savvy call buyer and I assume they wanted the dividend.

In the case of the May 20, 2016 call , the ex-dividend date was May 17, 2016.  I was in no danger of losing MSFT to the call buyer because it was trading around $51.75 and the buyer would need to pay me $55.

I collected the May dividend and July 20, 2016 I sold another call on these shares.  The strike price this time was $60 and the premium I received was $.85 the expiration date was 10/21/2016.   I always like the premium to be no less than 1% of the strike price.  I love being able to raise the strike price on a stock as my gain increases should the stock be called away. 

Again this call expired as MSFT was trading right at $60 and apparently the call buyer did not want to take the risk to go long.  During the waiting time, I collected another dividend.  After the call expired, I waited for the next opportunity and collected yet another dividend.

Finally on March 2, 2017, I sold one more call on this 100 shares of MSFT.  I was able to move up the strike price to $65 and received a premium of $1.06.  The call expiration was 4/21/2017.  This call was assigned.  Microsoft closed at $66.40 on April 21 so the call buyer paid me $65 for my stock plus the $1.06 to buy the call.  His/her basis is $66.06.  They made a whopping $.34 so far.  See the table below

For me this is the perfect use of covered calls on a dividend stock.  MSFT may move up a lot more and I have more shares in my stable.  As a matter of fact I sold additional calls of $67.50 and $70.

The point of going through the detail of this trade is to show how well covered calls on dividend stocks can work to your benefit.   Now let's look at Lilly

Eli Lilly $80 4/21/2017 - An example of lost opportunity

LLY is a very interesting case.  The only thing Lilly and Microsoft have in common is they are both dividend stocks. MSFT yields 2.4% and LLY yields 2.57%.  Both are a bit pricey when you look at P/E ratios (price to earnings ratio.)  MSFT carries 31 P/E with a forward P/E of 20.5 and LLY 31.74 with a forward P/E estimate of 19.94 earnings growth is expected at both companies.

When I bought LLY,  November 1, 2016  at $73.30 I did it because the calls were so lucrative.  I immediately sold an $80 call with an expiration date of 1/20/2017 for $2.43. This call expired without action.  During the waiting period I collected the November dividend.

LLY's stock price languished in the  $75 to $77 range.  Not long after the above call expired, I sold another call ; a 4/21/2017 with a strike price of $80.  I was not so sure how LLY was going to perform and I was willing to let someone take it.   In this post I am only covering this 100 shares but I will tell you on a later date I received $3.94 for an $85 call.  Calls were robust but once I sold the 4/21 $80, I was stuck with having to sell if the call buyer exercised their option to buy my shares.

That is indeed what happened and Lilly scooted up to $86.34.  I was sure my $80 was gone.  LLY then backed up and closed at $81.89 and that was good enough for the call buyer; they took my shares.  The table below shows the details.

This trade illustrates the lost opportunity of having to hold a stock because it is on call and not being able to sell it when it surges.  The next two calls show how you can get stuck with a looser using covered calls.

Kohl's $47.50 4/21/2017 - A wash

I bought Kolh's, symbol KSS, on January 6, 2017 at $41.50 and I immediately sold a $47.50 April 21, 2017 call and received a premium of $2.01.  This call expired this last Friday and I received the March dividend during the waiting period.

You will see in the table below that KSS has not been an awful trade.  It closed at $40.07 on Friday so the call buyer did not take these shares at $47.50.  I am hoping to sell more calls as I would like to keep the stock in view of their robust dividend; yield is 5.62%.  With the income from the dividend and call, I technically have a wash.  But it is a loss on my basis and that is always worrisome in an industry like retail.  

Gilead $77.50 4/21/2017 - Stuck with a loser

Gilead, GILD, is a real stinker.  I wrote up an article about why I like GILD even though it is hanging around the 52 week low.  This is one cheap stock with a pretty good balance sheet.  I don't know how long it will take to turn it around but with a yield of 3.1% and still good earnings, I am suffering with this holding.  

I bought this lot of GILD on August 16, 2016 at $79.59.   I immediately sold an $85 10/21/2016 for $1.10.  Again during the waiting period, I received the dividend but the stock price was gradually sliding to around $75.   That call expired and January 30, 2017, I sold another $85 call.  This one had an expiration date of 4/21/2017 and I received a premium of $.90.   The table below has all information.

Since I sold the April call, the stock price has eroded.  It closed at $65.93 on Friday.  I don't like having an investment with a 17% loss and this illustrates the perils of using covered calls.  It I may be too late to sell.  Covered calls barely help soothe the pain.

Covered calls are a two edged sword even when employed on dividend stocks.  When I look at all 9 calls I had working, 2 were assigned and 7 expired.  GILD is really the only stinker. 

Qualcomm, QCOM, and National Health Investors, NHI,  like KSS are weak.  Eaton, ETN, and International Paper, IP, are winners like MSFT.

I will still use covered calls on dividend stocks as it has been a winner but you should be aware of the risks and I hope this post helps you.

M* MoneyMadam

Disclosure: Long MSFT, LLY, KSS, GILD, QCOM with calls.  Long ETN, IP, and NHI.

Tuesday, April 18, 2017

CVS reinventing the pharmacy business and my next 2017 Dividend Machine

  • Reinventing the Pharmacy business
  • Services from in home infusion to quick care clinics & senior center pharmacy management
  • Implementing pharmacy benefit manager services
  • Positive Dividend Machine Fundamentals

A quick look at the CVS website reveals the evolution of this former pharmacy.  CVS is now CVS health.  They are not just a pharmacy anymore although with 9,600 pharmacy store locations, pharmacies remain a big part of their business.   68,000 retail network pharmacies and 35 specialty pharmacies complement their basic business.  They have developed the pharmacy benefit manager process to diversify their role in health care.  Moreover, they provide health care through 1,100 minute care locations and 60+ health system affiliations. 

As CVS says, it is reinventing the pharmacy business.  Coram, an acquisition, is one innovation.  Coram provides infusion services in your home.  From acute care to long term care, CVS is trying to bridge the gap between primary care needs and management in long term facilities by acquiring Omnicare in 2015.

Overlay this strategic plan on their fundamentals and my analysis makes this stock a candidate for my 2017 Dividend Machine target portfolio.  


In this case, I am going to start with balance sheet which I measure as D/E (debt to equity ratio.)  Readers know this is important to me.  I like to keep the risk of my stocks going out of business due to over leverage to a minimum.  If D/E ratio is extravagant as it is in companies like Clorox at greater than 9 or even Verizon at greater than 4, risk from over leverage is real.

Current D/E  (debt to equity ratio) of CVS is .7475 up from an average of about .30 in previous years.   Interest coverage has similarly deteriorated but is still a respectable 9.  Walgreens Boots has a similar trend of increased debt over the past couple of years.  Debt was cheap so you can’t complain about driving growth with debt.  The chart below presents debt coming due over time with a lot of it due in 2045. 


My take when comparing CVS’s debt to the industry and its peers is that CVS is safe.

CVS Revenues

Let’s move onto Revenues, the mother’s milk of a company’s ability to pay out dividends.  For we income investors, we want income and we want income that grows.  If revenues are not growing you can forget about dividends growing.   

I stick with the simple connection of growing revenues don’t guarantee growing dividends but without growing revenues, sustained dividend growth is unlikely. A picture is worth a thousand words, therefore see the table below.

Next is dividend, dividend coverage and dividend growth

If there is one weakness for CVS it is that the dividend yield is about 2.5%.  I prefer a higher yield.   I seek something greater than the 10 year U.S. Treasury yield which today is about 2.25% so CVS does qualify. 

Note their fiscal quarter ending March should be reported the beginning of May, 2017.   I will not speculate on estimates, but price can vary and if you want a higher yield you may want to wait for a potential pull back in price should they not meet estimates. On the other hand, their results may be good and the price could go up.

Future earnings estimates are presented in the graph below (source Zacks.)


Earnings should never be less than deividends. We want a company that covers the dividend with an adequate amount of earnings and CVS meets that requirement.  Look at the table below and you will see a very encouraging trend.  Dividend payout coverage has increased for no fewer than the past five years. 

Dividend yield is o.k. at today’s price of $78.25 and dividend coverage history is very encouraging so let’s turn to dividend growth.  CVS’s most recent dividend increase was in January 2017.  They raised the dividend from $.425 per quarter to $.50 per quarter or a 17% increase.  There is not a dividend growth investor who would not like that. Yet, as the chart below presents, dividend growth is decreasing. 


This slow down of dividend growth suggests to me that I will watch this holding closely personally although in my tracked portfolios I do not buy or sell once I add a holding.  At 17% dividend growth, we have some room to wait for revenue and earnings to pick up and stimulate greater dividend growth. My take is the dividend is safe but the dividend growth rate may not equal past performance.

2017 CVS’s Dividend Machine Fundamental Overview

The first table below outlines my criteria for a 2017 Dividend Machine.  The second table presents how CVS performs.


Second table shows if CVS passes the hurdles set above.

I will add CVS to my 2017 portfolio.  I am hoping for a pull back but I will not wait much longer.

M* MoneyMadam

Disclosure:  No position but could add within the 72 hours.