Monday, March 26, 2012

The one that got away!


This post describes one of four covered call strategies that active investors use in today’s market.

Let's say you own a company that pays a dividend and you consider selling a covered call to boost your income.  Here is my story of Total.

Total (symbol TOT) is in my portfolio to take advantage of both a big dividend yield and a weak dollar.  Things change and the dollar may not be weak forever.  Moreover TOT does not qualify as a dividend machine so maybe it is okay to lose it via a covered call play.  Use my covered call calculator to see if you would do the same thing or if you think I made a mistake.

For instance TOT closed at $54.79 on March 26, 2012.  If I bought TOT for the big 7.2% yield and sold a May $57.50 call for .55 my gain is not that good.  But if I look at the call on my cost basis of $47.09 the return is pretty impressive.  The two tables below illustrate the difference.


CALL OPTION
TOT
Strike Price
$57.50
Cost Basis
$54.79
Call Premium
$0.55
Dividend
$0.00


Gain in $ if assigned
$3.26
Call Yield
0.96%
Gain Yield
5.67%
Total Gain Yield
5.67%


The above table illustrates the results of buying TOT today and selling a call.  I do not like only a 5.66% total gain even if it is on a stock that currently yields 7.2%.  My reason is that TOT is not a dividend machine.  The yield varies all over the place.  The income changes based on the value of the dollar and generally speaking Europe, Total is French Company, is more volatile than the U.S. in terms of dividend income. 


CALL OPTION
TOT
Strike Price
$57.50
Cost Basis
$47.09
Call Premium
$0.55
Dividend
$0.00


Gain in $ if assigned
$10.96
Call Yield
0.96%
Gain Yield
19.06%
Total Gain Yield
19.06%


On the other hand, I am very happy that I bought TOT a while ago so I have a gain.  If I sell this call, I have good chance that the call purchaser will also buy my shares. 
The lesson of this post is if you sell a call that is close to the current price and has a high probability of being assigned, and you sell the call on a stock in which you have a gain, it is hard to lose.

It takes a little bit of work to find these opportunities, but it is so worth it.
Very Truly Yours,

TheMoneyMadam