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.