Covered call writing is a low-risk strategy that allows us to generate monthly cash flow by selling stock options. Since we are obligated to sell our shares to the option buyer (holder), one of the understood possibilities is that we will “lose” our shares at the strike price or the price we have agreed to sell our shares for mid-contract. For most of us, this is not a disadvantage but rather a positive because, if it occurs, we will have maxed our trade results and now have the cash from the sale of the stock to re-invest mid-contract.
The chance of “early assignment” (option exercised and shares sold prior to expiration Friday) is extremely rare. When it does occur it is usually related to a dividend distribution. The general rule is that if the ex-dividend date (date we must own the shares to be eligible to earn the dividend) is prior to the expiration date of the option and the time value of the premium is less than the dividend about to be distributed the chance of early exercise is much greater but not guaranteed.
This article is geared to members of our BCI family who use covered call writing in their buy and hold portfolios to generate higher annualized returns but do not want their shares sold. Usually, these portfolios are held in non-sheltered accounts with securities that have a low cost basis and there are tax issue concerns if shares are sold. For some of our members, these shares have been generating monthly dividends that we would like to continue to flow.
Let me premise my remarks by saying that we can never guarantee that our shares will not be sold early because retail investors make mistakes. So even if it makes no sense to exercise early, some may, and those exercise notices may randomly end up in our accounts. Likely? No. Possible? Yes.
- Ex-dividend date is prior to expiration Friday
- Time value component of the option premium < the dividend about to be distributed
- We don’t want our shares sold
2 Methods of dramatically reducing the chance of early exercise:
The first step is to locate ex-dividend date data for the security as shown in the screenshot below for American Express:
The site I used to access this information:
1- If the ex-date is in the 1st week of a contract, sell the option the day after the ex-date (and still capture 3 weeks of time value).
2- If the ex-date is later in the contract, sell a 2-month option after expiration of the previous contract. When the ex-date is not close to the expiration of the contract, an option holder will rarely exercise early.
There are methods we can employ to dramatically decrease any chance of early exercise due to dividend distribution but we can never be 100% certain of avoiding such events because of potential errors made by retail investors (may “spend a dollar to make 50 cents”).
Next live seminar: Coral Springs, Florida:
I will be in SE Florida for 11 days in early September attending to family real estate business and was invited to speak at a local options club which meets 15 minutes from where I’m staying. As many of you know, I’ve never met a microphone that I didn’t want to speak into when it comes to covered call writing, sooooo….
South Florida Options Trading Forum
Thursday September 11th
This week’s reports were mixed but positively reflecting a growing and expanding economy overall:
- The 2nd quarter annualized GDP rate was revised upward to 4.2% from the first estimate of 4.0%. This is in contrast to the 1st quarter contraction of (-)2.1% due to the winter slowdown
- Personal income rose to $14.7 billion
- Corporate profits rose by 8.0% compared to (-)9.4% in the 1st quarter
- New home sales declined for the 2nd straight month in July according to the Commerce Department. The annualized rate came in @ 412,000 while 430,00 was expected
- The average sale price of new homes rose 2% in July and was up 3% year-over-year. The current average is $339,100
- According to the national Association of Home Builders/Wells Fargo Housing Market Index rose in July for the 3rd consecutive month, up 2 percentage points to 55
- Personal spending in July decreased 1%, the first decline since January
- Personal income rose by 0.2% in July, less than the 0.3% anticipated
- According to the Commerce Department, new orders for durable goods in July rose an impressive 22.6%, more than tripling the 6.9% expected. This was the highest rate increase ever recorded
- The Conference Board’s Consumer Confidence Index rose in August for the 4th consecutive month to 92.4, the highest level since October, 2007. Economists had projected a reading of 89.0
For the week, the S&P 500 rose by 0.7%, for a year-to-date return of 10%, including dividends.
IBD: Confirmed uptrend
GMI: 6/6- Buy signal since market close on August 15, 2014
BCI: Moderately bullish favoring out-of-the-money strikes 3-to-1
Wishing the BCI community a happy and safe holiday weekend,
Alan and the BCI team ([email protected])