The parameters of our covered call trades are often changed when certain corporate events result in option contract adjustments. These events include stock splits, mergers & acquisitions as well as special 1-time cash dividends. This article will analyze a real-life example with Ford Motor Company (NYSE: F) and how a regular dividend, a special 1-time cash dividend and a covered call trade resulted in contract adjustments.
F Trade data
- 2/8/2023: F trading at $13.48
- 2/8/2023: The 2/24/2023 $13.50 call is in place
- 2/8/2023: The bid – ask spread for the $13.50 call is $0.32 – $0.34
- 2/10/2023: This is the ex-dividend date for a regular dividend of $0.15 as well as a special 1-time cash dividend of $0.65. This will result in a contract adjustment for the $13.50 call
The Options Clearing Corporation (OCC) contract adjustment published information
F Contract Adjustment Effective 2-10-2023 (the ex-dividend date)
Note that under “Strike Prices”, the strikes will be reduced in value by $0.65, the amount of the special 1-time cash dividend. This is because share value will decline by $0.65 on the ex-date due to this unusual event. There is no reduction in strike price for the regular quarterly dividend, as that one was anticipated and baked into the option pricing previously.
Will the call buyer exercise the option in order to capture the 2 dividends?
If the option buyer does exercise to capture the 2 dividends, the time value of $0.32 would be lost and shares would be purchased at a slightly higher price than current market value. Can it happen? … Yes. An inexperienced retail investor would have to serve an exercise notice to their broker and ultimately off to the OCC and back to the seller’s broker and then to the seller. Unlikely, but possible.
The better approach for the option buyer would be to sell the option (capturing the time-value of $0.32 per-share) and then purchase shares at market price to then capture both dividends. As rare as this is, if retaining the shares is critical to our trading strategy, there should be no option in place prior to the ex-date. The covered calls can be written on or after the ex-date.
Discussion
Our option contract parameters can change as a result of certain corporate events, including special 1-time cash dividends. Early exercise is rare but may occur as a result of investor error.
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Hi Alan:
I absolutely love your books. Read them all. You have such a smooth way of make your point. I’m a 75-year-old retired college professor. I know good writing technique when I see it. I’ve been selling covered calls for 30 years to supplement my retirement income. I wish I knew you back then.
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Alan,
Lets say I buy QQQ or SPY or any stock 100 shares each and sell one call every week ATM and collect say a premium of say 2% per week.
OR 52 weeks @ 2%/week equal to ~ 100%.
Will I be profitable at the end of the year?
Any thoughts or any research into this strategy?
Thank you.
Neville
Neville,
I will summarize your strategy proposal and then follow that up with some comments that should be useful.
SUMMARY:
1. You are using broad market ETFs as your underlying securities which will provide instant diversification, SPY more so than QQQ.
2. Only ATM strikes will be sold on a weekly basis.
3. I’m making the assumption that you have mastered all aspects of position management (exit strategy implementation).
COMMENTS:
1. By using ATM call strikes, there is a susceptibility to exercise > 50% of the time in normal market conditions. A plan must be in place to deal with this scenario.
2. If exercise does occur due to share appreciation, shares must be re-purchased at a higher price. Cash must be available to deal with this outcome.
3. QQQ has been one of my favorite ETFs to use in my option-selling portfolios over the past 2+ decades. However, it is not always a security we should be using (when tech stocks are out of favor). An excellent security, frequently … Yes; always? No.
4. Based on historical data (previous studies), using no exit strategy intervention, this proposed strategy should slightly beat the market with less portfolio volatility.
5. Much better results should be achieved by being open to selecting the best-performing stocks or ETFs at the time of the trades.
6. Much better results should be achieved by being open to broader strike considerations … ITM when we need defensive protection and OTM in normal to bull markets.
7. Much better results should be achieved by using our exit strategy arsenal when those opportunities present.
Bottom line: You’re off to a great start that can be made even better.
Alan
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Alan,
What resource do you suggest for implied volatility when using your expected price movement calculator?
Thank you.
Andrea
Andrea,
The option-chain data from your online discount broker typically will have this IV data. Use the at-the-money strike IV to insert into the BCI Expected Price Movement spreadsheet.
Here are 2 more suggestions:
1. Use the IV stats from this free site:
https://www.cboe.com/delayed_quotes/vix/quote_table
2. Use the “IV index mean” from the ivolatility.com site (also free). See the screenshot below for an example with AAPL.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
Alan
Alan,
What is wrong with the strategy of buying a stock @50- covered call @55 and sell stop @45?
Worst case scenario I lose $5 a share, minus my covered call premium, right?
Thanks,
Mike
Mike,
We can’t close our long stock position before removing our short call contractual obligation. If we sold the stock first, the call in place would be “naked”, not “covered”. Brokers would not allow us (retail investors) to do this.
This is why, at BCI, we have the 20%/10% guidelines for closing the short calls, and then deciding our next action, which could be selling the stock, depending on other factors detailed in my books and videos.
To accomplish your suggested strategy, you could watch the price of the stock, and when it reaches the pre-stated threshold, first buy back the option and then sell the stock.
Another approach would be to buy a protective put as insurance against catastrophic share price decline. This is known as the collar strategy. Our returns will be lower because we have to pay for the long put.
Alan
Alan,
It all makes sense now. Thanks
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