Building Inventory For Covered Calls

Covered Calls are a powerful tool and strategy to boost earnings. I've heard of using this some time ago, but after looking into it realized there are many factors to consider:

1) Commission costs.

2) What if shares go down below cost?

3) What strike price?

4) What expiry date?

5) What companies/stocks to purchase?

Here's how I'm playing the Covered Call writing strategy. I have been accumulating shares in several larger dividend companies in order to write Covered Calls on them. As per most who follow this strategy the goal is to enhance returns by extracting premiums and create a certain discipline for selling/refreshing my stocks every now and then.

However, to maintain a position for my long term goal of dividend income generating portfolio I maintain synthetic Dividend ReinvestmentPlans and will allot a portion of the shares for writing.

So far I've built up positions in BNS, CWB, MFC, and SLF for writing. I still don't feel they are large enough to more efficiently generate Premiums. As you'll see, below are my target number of contracts to write. This builds in an initial Call writing and if the Premium increases; provides flexibility to average into the Premium.

Positions:

Stock	Avg Cost	Current Price	# of Shares	Target # of Contracts
BNS	$57.05	$57.95	500	2-3
CWB	$26.04	$23.56	600	2
MFC	$19.92	$21.24	1000	4
SLF	$40.78	$44.07	600	2

1) Commission Costs.

I use both Questrade and BMO InvestorLine; and for Option trading the commissions are fairly similar, but BMO IL's charges $0.25 more per contract.

Taking Questrade as an example here's how it looks like:

Option Commission: $9.95

Option Cost Per Contract: $1.00

If I write/buy 2 Contracts that means I pay $11.95 ($9.95 Option Commission + 2 Contracts x $1.00).

The biggest difference is with Option assignment.

Questrade is more competitive by far, charging a flat $24.95.

BMO IL has a minimum $43 + laddered contract cost depending on the Option price, starting at $1.50 per Contract.

https://www.bmoinvestorline.com/selfDirected/pdfs/FeeSchedule_EN_May.pdf

Regardless of stocks or options the Commissions can have a significant impact on your profits/losses/break evens.

Example:

On December 21, 2015 I wrote a single Call option on CWB (160415C26.00):

Date

Symbol

Type

Expiry

Strike

Quantity

Price

Gross

Commission

Net Price

Net Amount

Exposure

Status

Type

2015-12-21

CWB

Call

04/15/16

26

1

$0.7000

$70.0000

$10.95

$0.5905

$59.05

$0.00

Open

Covered

Strike: $26.00

Expiry: April 15, 2016

Premium: $0.70 ($0.70 x 100 = $70)

Commission: $9.95 + $1 = $10.95

Net Premium: $70-$10.95=$59.05

This means in 4 months if the share price appreciates to $26 or higher 100 shares of my CWB will be sold to the Call contract owner. This means I sold insurance to another investor for roughly $14.76 per month. In addition I will receive an additional dividend payment of $23 on the 100 shares before contract expiry since ex-dividend is approximately March 16-19.

The heaviest commission will be with the potential assignment. At $24.95 commissions will eat up 42.2523% of the profits, leaving me with $34.10. Looking at it another way I basically sold for $0.3410 per share over $26. $26.341 Assignment Price - $26.04 Average Cost = net profit of $30.10.

If there is no assignment then I'll get to keep the $59.05 and I can continue writing.

Here's where not selling the full number of contracts comes in; if the share price rises closer to $26 then the Premium will increase as well. I can wait until the shares come close to $26 (or higher) and average in by writing a second Call for a higher Premium. If the shares fluctuate and decline afterwards I then have a choice of Buying to Close (BTC) the position.

2) Going underwater on my investment.

This is tough as my CWB example shows my average cost is $26.03, but share price is at $23.56. Holding for the long term I have a combination of choices. a) write a put to accumulate more shares via assignment and/or try to gather more premiums, and b) wait for a fluctuation in the price and write a Call closer to my break even.

Instead of writing a new Put due to existing exposure; I opted to write a Call as the share price bounced from lows to $23's.

3) Choosing Strike Price

This depends on the current stock price. Targeting higher Strikes Out of the Money will garner a smaller premium. Closer to share price gives a better premium.

4)  Expiry Date

This also factors into the Premium. Further out gives you higher Premium.

5) Company/Stock Types?

I want dividend type stocks to achieve long term income goals. So, the safest is to target these stocks.

My Option Writing Book - Checking the Options Inventory (Dec 24, 2015)

In previous posts I've copy and pasted snapshots from my Option Writing Book.

I use this Option Book to keep track of my existing positions' expiry dates, premiums, and exposure to potential assignments. I've also got calculations of my expired and assigned positions as well. I've got basic calculations down, but when it comes to more complicated average costs and partial sells I'm continuously working on simplifying calculations for my Options Book.

As of Thursday I have multiple open Put positions on EMP.A, BCE, SJR.B, GWO, T, BNS, MFC, and BAC. In total potential assignment Exposure of $61,700. I have a single Covered Call position on CWB that could bring in $2,600. In total from these open positions I have gathered Premiums of $2,131.65. However, it makes sense to not record the Premium as a gain until the position expires or until I close the position via Buying to Close (BTC) a contract. If the position is closed; the potential premium gained will be less. Keeping account of the Premiums like this helps as the option position remains a liability on my end until BTC or expiry. It also prevents one from becoming too optimistic with the gains.

Taking an example entry for BCE, if on Expiry Day less than 2 months out on February 19, 2016 the Share Price falls below the Strike Price of $54 then my 3 Option contracts will be executed and I will be assigned (purchase) 300 of the underlying shares.

On the flip side I have one open Covered Call position on CWB that expires almost 4 months out on April 15, 2016. This Call allows me to sell 100 shares if the price is $26 or greater.

While a total exposure of $61,700 seems like quite a bit and if the market tumbles significantly across the board I will be very likely responsible for the amount; potentially I could BTC the options and take significant losses to cover.

A sore point is my January 15, 2016 X Put @ $46. That is going to hurt a lot since the stock plummeted from around $46 to a low of $33.30 since I wrote it for a now paltry Premium of $1.30. As the stock dropped the Premium increased matching the losses. While the stock jumped a bit over the last few days on the low volume holiday period; upon assignment in January at $33.30 I would be taking an immediate paper loss of $12.70/share. In addition, I have an existing position and had written this Put to average down.

I also had CWB Puts that were assigned on December 18th and averaged down my existing position.

However, again as always, I write Put Options of stocks that I would not mind owning and lean towards larger capitalization companies.


Expiry Dates:
01/15/16: 2 Put Positions
02/19/16: 3 Put Positions
03/18/16: 1 Put Position
04/15/16: 2 Put Positions + 1 Call Position
05/20/16: 1 Put Position

Open
Date	Symbol	Type	Expiry	Strike	Quantity	Price	Gross	Commission	Net Price	Net Amount	Exposure	Status	Type
2015-12-17	SJR.B	Put	01/15/16	25	3	$0.8500	$255.0000	$13.70	$0.8043	$241.30	$7,500.00	Open	Uncovered
2015-12-21	SJR.B	Put	01/15/16	25	1	$1.4700	$147.0000	$11.20	$1.3580	$135.80	$2,500.00	Open	Uncovered
Total	SJR.B	Put	01/15/16	25	4	$1.0050	$402.0000	$24.90	$0.9428	$377.10	$10,000.00	Open	Uncovered
2015-11-26	X	Put	01/15/16	46	1	$1.3000	$130.0000	$10.95	$1.1905	$119.05	$4,600.00	Open	Uncovered
2015-12-16	BCE	Put	02/19/16	54	2	$1.0100	$202.0000	$12.45	$0.9478	$189.55	$10,800.00	Open	Uncovered
2015-12-17	BCE	Put	02/19/16	54	1	$1.8000	$180.0000	$11.20	$1.6880	$168.80	$5,400.00	Open	Uncovered
Total	BCE	Put	02/19/16	54	3	$1.2733	$382.0000	$23.65	$1.1945	$358.35	$16,200.00	Open	Uncovered
2015-12-21	GWO	Put	02/19/16	34	2	$0.9500	$190.0000	$11.95	$0.8903	$178.05	$6,800.00	Open	Uncovered
2015-12-23	BNS	Put	02/19/16	54	1	$1.0500	$105.0000	$11.20	$0.9380	$93.80	$5,400.00	Open	Uncovered
2015-12-23	BAC	Put	03/18/16	18	2	$1.3000	$260.0000	$12.45	$1.2378	$247.55	$3,600.00	Open	Uncovered
2015-12-21	CWB	Call	04/15/16	26	1	$0.7000	$70.0000	$10.95	$0.5905	$59.05	$0.00	Open	Covered
2015-12-02	EMP.A	Put	04/15/16	25	2	$0.9500	$190.0000	$12.45	$0.8878	$177.55	$5,000.00	Open	Uncovered
2015-12-11	EMP.A	Put	04/15/16	25	2	$1.4000	$280.0000	$12.45	$1.3378	$267.55	$5,000.00	Open	Uncovered
Total	EMP.A	Put	04/15/16	25	4	$1.1750	$470.0000	$24.90	$1.1128	$445.10	$10,000.00	Open	Uncovered
2015-12-23	EMP.A	Put	04/15/16	25	2	$1.0000	$200.0000	$12.45	$0.9378	$187.55	$5,000.00	Closed	Uncovered
Total	EMP.A	Put	04/15/16	25	2	$1.1750	$270.0000	$24.90	$1.1128	$222.55	$5,000.00	Open	Uncovered
2015-11-30	MFC	Put	04/15/16	21	2	$0.8600	$172.0000	$12.45	$0.7978	$159.55	$4,200.00	Open	Uncovered
2015-12-15	MFC	Put	04/15/16	21	1	$1.3900	$139.0000	$11.20	$1.2780	$127.80	$2,100.00	Open	Uncovered
Total	MFC	Put	04/15/16	21	3	$1.0367	$311.0000	$0.00	$1.0367	$287.35	$6,300.00	Open	Uncovered
2015-12-17	T	Put	05/20/16	38	1	$2.0000	$200.0000	$11.20	$1.8880	$188.80	$3,800.00	Open	Uncovered
										$2,131.65	$61,700.00	$59,568.35

More distractions writing more Puts. Dislocations in Canadian Telecoms: $SJR.B Shaw announced purchase of Wind Mobile

Wednesday December 16, 2015 was an interesting day.  The Fed announced its first rate increase in 7? years.  Many were holding their breaths for that day and the market had been declining for some weeks.  That is until the Monday when markets started turning upwards. Post-Fed, the markets surged higher.

In Canada, after hours it was announced that Shaw will purchase Wind Mobile for $1.6 Billion. I was driving home at that time and my jaw dropped as I thought how the telecom landscape in Canada will change. Well, that and the fact that I intended to add to my BCE position and that day wrote two February Puts @ 54. Fun times.

http://newsroom.shaw.ca/corporate/newsroom/news/2015-12-16-Shaw-Communications-Inc-to-Acquire-WIND-Mobile-Corp/

http://business.financialpost.com/fp-tech-desk/shaw-communications-inc-to-acquire-wind-mobile-corp-in-1-6-billion-deal

Date

Symbol

Type

Expiry

Strike

Quantity

Price

Gross

Commission

Net Price

Net Amount

Exposure

Status

Type

2015-12-16

BCE

Put

02/19/16

54

2

$1.0100

$202.0000

$12.45

$0.9478

$189.55

$10,800.00

Open

Uncovered

Shaw operates primarily in the West Coast and had originally sought to develop its own teleco division.  Wind Mobile being a smaller and developing new entrant didn't have the scale to compete with incumbents Bell, Rogers, and Telus.

Mostly as expected today Thursday December 17, the major telecos took a hit on the anticipated changes to the competitive landscape in Canada. In particular, Telus bore the brunt of the news as they will get heavier competition in its home area of the Canadian West Coast.  This was evident from the share price declines and intra day they were down even more.

Closing Prices:
Rogers Communications RCI.B $47.45 -$2.81 -5.59%
BCE Inc. BCE $53.52 -$1.34 -2.44%
Shaw Communications Inc SJR.B $24.90 -$2.07 -7.68%
TELUS Corporation T $37.92 -$2.70 -6.65%

However, of interest was Manitoba Telecom (MBT $29.65 +$0.62 +2.14%). I've been looking to get back into this one since they completed their AllStream sale, which was said to be holding back other companies from taking out MBT. I likely will not pick up some shares, just because as you will see below am now potentially fully invested in telecoms.

Regardless, I believe Shaw needs Wind as a source of revenue and will benefit from this acquisition as it gets integrated into the company.  I wrote three January Puts @ 25:

Date

Symbol

Type

Expiry

Strike

Quantity

Price

Gross

Commission

Net Price

Net Amount

Exposure

Status

Type

2015-12-17

SJR.B

Put

01/15/16

25

3

$0.8500

$255.0000

$13.70

$0.8043

$241.30

$7,500.00

Open

Uncovered

Then I decided the price was right to add a bit more Telus so I wrote one May Put @ 38:

Date

Symbol

Type

Expiry

Strike

Quantity

Price

Gross

Commission

Net Price

Net Amount

Exposure

Status

Type

2015-12-17

T

Put

05/20/16

38

1

$2.0000

$200.0000

$11.20

$1.8880

$188.80

$3,800.00

Open

Uncovered

Whooopss... I totally messed up the Telus Put. Bid/Ask Spread was pretty wide. Bid: $1.80, Ask $2.63. Yea, I wrote for $2.00 and it hit when the stock dipped to the mid-$37s.  Totally not cool considering:

a) Stock was around $37 and strike at $38, means at least $1 of the premium is justified.

b) 5 months of time value would have been worth more than the second $1 of premium.

Hence, kicking myself a bit.

As Bell went down, I want to average up the Premium to give more flexibility to pare down later if necessary/possible. Added 1 more Put @ $1.80.  Average Premium is now $1.2733

Date	Symbol	Type	Expiry	Strike	Quantity	Price	Gross	Commission	Net Price	Net Amount	Exposure	Status	Type
2015-12-16	BCE	Put	02/19/16	54	2	$1.0100	$202.0000	$12.45	$0.9478	$189.55	$10,800.00	Open	Uncovered
2015-12-17	BCE	Put	02/19/16	54	1	$1.8000	$180.0000	$11.20	$1.6880	$168.80	$5,400.00	Open	Uncovered
Total	BCE	Put	02/19/16	54	3	$1.2733	$382.0000	$23.65	$1.1945	$358.35	$16,200.00	Open	Uncovered

Having Shaw's clout will allow Wind to grow over the longer term.  However, I think there is some opportunity from the dislocation caused by Shaw's move into the Telecom market.  Today's price drop is likely an overreaction as:

1) Wind has existed for some time and its impact on the telecom market is already present.

2) Shaw will take some time to digest Wind and the actual deal isn't expected to close until mid-2016.

3) It will cost Shaw a lot of time, money, and focus/attention to build up/upgrade Wind assets. Although they kept the Wind team in place, attention will still be costly if they want to keep reins on them and oversee developments.

4) Shaw will need to finance this move (TD+CIBC).

Transaction Terms & Financing

Under the terms of the Transaction, Shaw will acquire 100% of the shares of WIND‟s parent company, Mid-Bowline Group Corp., by plan of arrangement, for an enterprise value of approximately $1.6 billion based on quarterly financial statements as of September 30, 2015. Shaw has executed a fully-committed bridge financing facility with the Toronto Dominion Bank and the Canadian Imperial Bank of Commerce. Shaw is committed to a financing plan that maintains its investment grade status and accordingly will optimize the significant flexibility available to it, including potential debt issuance, asset sales, the issuance of preferred or common equity or any combination thereof. Additional details regarding the longer term financing of the Transaction will be provided prior to close.

- http://newsroom.shaw.ca/corporate/newsroom/news/2015-12-16-Shaw-Communications-Inc-to-Acquire-WIND-Mobile-Corp/

5) Shaw will likely end up raising pricing to the same level as incumbents in order to cover costs of above points (am I being pessimistic?).

In any case, I've effectively added a not insignificant $27,500 exposure to the Canadian telecom space and will need to be cautious.  Fortunately, it appears the decline in prices is starting to be cleared out as the day's close the declines were reduced somewhat.  There appear to be more macro risks at play though in the general markets, which could take the teleco's down alongside.