In Part I of this series, we discussed mergers involving cash settlement only. These events do impact our covered call and put-selling positions. In this article we will highlight mergers that involve both cash and stock and demonstrate how these corporate events can alter our option contract positions.
Company XYZ is merging into Company BCI and BCI is paying for each share of XYZ, 1/2 share of BCI + $5.00 per share: 100 XYZ = 50 BCI + $500.00
The $500.00 remains a fixed amount despite any change in share price of BCI by consummation of the merger.
Changing option symbol
XYZ calls and puts will now trade as BCI1 calls and puts and continue to trade until they expire:
Calculating the “moneyness” of the $25.00 call strike if BCI is trading at $30.00
The aggregate exercise amount per contract ($25.00 x 100) = $2500.00 both before and after the merger. We know that when BCI1 is exercised, 50 shares of BCI + $500.00 is deliverable. If BCI is trading at $30.00 per share, the current contract value is $1500.00 + $500.00 = $2000.00 or $500.00 less than the aggregate exercise amount. This means that the call is out-of-the-money by $500.00.
Eagle Rock Partners, L.P. (“EROC”) Merger COMPLETED
with Vanguard Natural Resources, LLC (“VNR”)
Shareholders of Eagle Rock Partners, L.P. (“EROC”) voted on Monday, October 5, 2015, and
approved a proposed Merger between EROC and Vanguard Natural Resources, LLC (“VNR”).
Pursuant to the terms of the Merger, each EROC Common Unit outstanding immediately prior to the
consummation of the Merger will be converted into the right to receive 0.185 of a Common Unit of
VNR. The Merger became effective today, Thursday, October 8, 2015.
Pursuant to Article VI, Section 11, of OCC’s By-Laws, all outstanding EROC options shall be
adjusted as follows. On Friday, October 9, 2015 each adjusted Eagle Rock Partners, L.P.
contract will require the receipt or delivery of: (A) 18 Common Units of VNR; plus (B) cash in
lieu of 0.5 fractional Common Unit of VNR. Premiums for the adjusted Eagle Rock Partners, L.P.
options will continue to be calculated on the basis of a multiplier of 100, i.e., for premium and strike price
extensions, 1.00 will equal $100. The Eagle Rock Partners, L.P. option symbol will change to
VNR2. [Any FLEX series that may exist will be adjusted in a similar manner to the standardized
Corporate events like stock splits, special dividends, spinoffs and mergers and acquisitions usually result in option contract adjustments which impact our covered call writing and put-selling positions. These changes are made to make both option buyers and sellers “whole” but we still must understand how are contracts are impacting to then allow us to make the best investment decisions. Our brokers will have access to this information or we can call the OCC at 1-888-678-4667 or go online at www.cboe.com and look for contract adjustments.
For more information on contract adjustments:
Complete Encyclopedia for Covered Call Writing- Classic:
Pages 193 – 196
Pages 323 – 332
Complete Encyclopedia for Covered Call Writing- Volume 2:
Pages 179 – 183
Pages 299 – 308
Next live appearance
American Association of Individual Investors National Conference
Las Vegas, Nevada
November 7th – November 9th
Sunday November 8th @ 8:30 AM – 9:45 AM (Alan’s seminar)
Exhibit Hall # 313
***Event is sold out
Coming soon: BCI contest
We’re trying something new thanks to Jay’s idea. Here are the initial parameters we are discussing: Two contests running simultaneously with six prizes:
Contest #1: What will be the value of the S&P 500 by year’s end?
Contest #2: In five sentences or less, give your reason(s) for your response (subjective, voted on by the BCI team)
Prizes in each category (total of 6):
- 1st place: Any DVD Program of your choice with signed Companion Workbook or any 3 books (signed) or a 1-hour 1-on-1 training session
- 2nd place: Any 2 books (signed)
- 3rd place: Any 1 book (signed)
- There will be 6 different winners
- Deadline for entering is November 30th
- A tie for contest 1 goes to the earlier entry
- No more than 2 entries per email address, one in October and one in November
- We will post contest leaders weekly in our blog (first name and last name initial only for privacy)
- Send entries to : my team is working on a landing page for this competition
Let us know what you think of this idea. I like it because it stimulates thought and discussion about the markets and the economy and we can all learn from each other. But this site is all about you so I will let you decide if this concept should continue in the future. We expect to get this launched within the next two weeks.
Muted economic data led to a rebound in global stocks, as investors expect central banks to extend their low-interest rate policies. Early corporate earnings reports were mixed, although large banks positively surprised. This week’s reports:
- US retail sales increased 0.1% in September. Rising automobile sales offset less expensive gasoline
- The University of Michigan’s preliminary consumer sentiment index rose from 87.2 in September to 92.1 in October
- The gauge of current conditions jumped from 101.2 to 106.7 over the same month.
- US industrial production fell for a second straight month in September, dropping 0.2% after a 0.1% decline in August
- Initial jobless claims fell 7,000 to 255,000 for the week ending October 10th matching a 42-year low
- Continuing claims declined 50,000 to 2.16 million for the week ending October 3rd
- The Consumer Price Index fell 0.2% in September while the core CPI, excluding food and energy prices, rose 0.2%
- Overall, prices were unchanged from a year earlier, but core prices rose 1.9%
- The Producer Price Index fell 0.5% in September, and core PPI dropped 0.3%
- For the year ending in September, the PPI was down 1.1%, while the core PPI was up 0.5%
For the week, the S&P 500 rose by 0.90% for a year to date return of (-) 1.25%.
IBD: Confirmed uptrend
GMI: 3/6- Sell signal since market close of October 14, 2015
BCI: Cautiously bullish favoring in-the-money strikes 2-to-1
Wishing you the best in investing,
Alan ([email protected])
I’ve noticed a lot more mergers and acquisitions this year than in the past. Do you view this as a positive sign for the economy?
Thanks for the article.
Absolutely and excellent observation. Most market observers consider and increase of M&A activity a positive signal for the market. In would take it further and say that other corporate events like stock splits (usually following a significant increase in share value) and one-time special cash dividends (usually the result of a cash-rich corporate balance sheet) are also positives for our stock markets.
This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 10/16/15.
Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:
Since we are in Earnings Season, be sure to read Alan’s article,
“Constructing Your Covered Call Portfolio During Earnings Season”. You can access it at:
Barry and The BCI Team
Earnings season is always a challenge locating eligible candidates for option-selling because so many securities (but not all) report in the same contract months. For our new members:
1- All the 8 eligible stocks on our running list (mid-report, MHLR, a 9th, currently does not have adequate open interest for near-the-money strikes) plus the list of exchange-traded funds from our recent report are currently available for your consideration for Monthly options.
2- Notice also that 4 more stocks (a 5th, EFX also currently does not have adequate OI) will become eligible during the 1st week of the November contracts when the earnings report passes (top of our “running list”). Since there are 5 weeks in the November contracts that will still give us 4+ weeks of option premium time value.
3- The stocks with a “Y” in the “Wkly avail” column can be used by writing Weeklys in 4 of the 5 weeks of the November contracts.
Although earnings season is a bit of a challenge, there are always ways of overcoming them while still adhering to our rules and guidelines.
Is it necessary to look up implied volatility before using an option? I have heard that iv is critical for options.
Implied volatility is extremely important but it is not necessary to look up IV stats for each position. We can assess the inherent risk of our positions by looking at the percentage returns of the options for near-the-money strikes. I set a goal of 2-4% for a 1-month return and may go as high as 6% in a bull market environment. Since percentage returns is directly related to the implied volatility of the underlying securities, by limiting the upper limits of these returns we are limiting the IV risk exposure.
Can you explain how downside protection works? I keep thinking its equivalent to breakeven? Can you give an example of the difference
Downside protection in the BCI methodology is referring to protection of the time value profit when using in-the-money strikes. Let’s set up an example and differentiate from breakeven:
Buy BCI at $32.00
Sell the $30.00 call at $3.00
Since we are decreasing share value by $2.00 (agreeing to sell at $30.00), the time value profit = $3.00 – $2.00 = $1.00. The remaining $2.00 from the $3.00 premium is used to reduce our cost basis from $32.00 to $30.00.
Therefore our initial profit = $1.00/$30.00 = 3.3%
This profit is protected as long as share value remains at or above $30.00 so our downside protection of the 3.3% is:
$2.00/$32.00 = 6.25%
This means that the 3.3% initial profit is guaranteed as long as share value does not decline by more than 6.25% by expiration.
Another way to frame DP for ITM strikes is that intrinsic value protects time value.
The formula for breakeven = share value when trade initiated – TOTAL option premium. In this case: $32.00 – $3.00 = 29.00.
One more question regarding your example. So my initial profit is $1/share or $100. If a few days later the stock drops to $31 what is my current profit?
Your profit is still $100.00 and will remain so unless share price declines below $30.00.
CALM: Dividend article:
The projected ex-date is 10/26 so don’t be concerned as share value will decline by the dividend amount as share owners will capture the equivalent dividend amount.
I have been trading options (mostly cash-secured puts along with covered calls) for about two years to generate monthly income, and have become fairly grounded on the terminology, mechanics, risks and rewards.
I recently purchased your book “Selling Cash-Secured Puts” (almost finished) and decided to joined the BCI premium membership based on the thorough research you and your team does on the underlying securities. It seems your site has a lot of rich data, research, and best practices on trading covered calls – less on cash-secured puts. Are the securities listed in the the Weekly Stock Screen and Watch List report appropriate for selling cash-secured Puts as well as covered calls or is there a separate list for each.
Thanks for your help.
One of the advantages of mastering both strategies is that we need only one watch list which will apply to both. The reason is that the risk/reward profiles are the same, strategy goals are generally the same and therefore the profile of the underlying securities are also the same.
You can use our Premium Watch Lists for both strategies.
Thanks for joining our growing community of Premium Members.
Do you trade Vanguard ETFs? If Not and why not?
Thanks in Advance.
Vanguard is a great company and I will absolutely use Vanguard ETFs when they meet our system criteria. This includes out-performing the S&P 500, minimum relative strength requirements, minimum trading volume and non-leveraged.
Vanguard ETFs do appear in our Premium ETF Reports from time to time.
So I will not include or omit a Vanguard ETF based on the name Vanguard but rather on passing or failing our system criteria.
Do you prefer to sell CC options in the morning or during the lull of the afternoon?
I execute the majority of my non-exit strategy trades between the hours of 11 AM and 3 PM ET when computerized institutional trading has subsided and so market volatility tends to be at a minimum.
Hi may I ask something. I have been noticing that buying calls deep within the money is very beneficial but it should just be around 2 week before expiration. Its almost 90% profit all the time but limits the upside to around 2-3%. I tried it with NFLX, AAPL, GPRO, my question is what draw back am I missing? Yes the upside will be limited but when the call is bought out, one can just repurchase the stock and do a deep ITM covered call. What I do is 10-15% deep ITM with open interest of atleast 100. If you have the time can you help me out what I am missing on why people don’t use this strategy thanks
The formula for actual initial profit when selling an ITM strike is:
(Total premium – intrinsic value/ (current stock price – intrinsic value)
This is the same thing as time value/strike price.
Deep in-the-money strikes tend to have little or no time value and 2 weeks into a contract theta has eroded the time value even more. Only highly volatile stocks will have a significant time value component for deep ITM strikes with 2 weeks to expiration.
Also, if you sold an ITM strike there is no upside because you have agreed to sell your shares for a price lower then current market value.
The advantage of the ITM strike is the downside protection you get of whatever time value was generated. Use the multiple tab of the Ellman Calculator to run the numbers.
You ask why other people do not use your strategy? First, I distrust anyone who says there is only one strategy. Your strategy is your own, Trust it as long as it works for you.
A few thoughts from a fellow BCI’er in addition to Alan’s always instructive reply: no two of us are alike. Which is why I love the dialogue here!
Since “never” is a big word I will say I would “rarely” write ITM calls on 3 marquee growth names like NFLX, AAPL and GPRO at the same time unless monster bearish. One of those horses is likely to run and you do not want him in ankle irons!
As we enter better market seasonality you may want to revisit your premise/goals for ITM writing: are you locking down a premium you can withdraw for cash use? Are you buffering anticipated loses?
Further, are you prepared emotionally for a stock to shoot up leaving you behind? Will you pay a hefty exit strategy premium to keep such a stock recouping some rolling forward? Or just let it go and be happy?
A favorite Jimmy Buffett lyric says “If our lives were that simple we’ld live in the past”
I have evolved to where I can not write calls on growth stocks unless uber-bearish. And then OTM because I do not trust my own timing.
But my goal is not monthly premium. It is total return. It seems I have a better swing at that ball if I over-write my dividend stock portfolio and let my growth portfolio run free.
But who knows if that will work tomorrow?
As the late great Yogi Berra quipped, “The future ain’t what it used to be”! – Jay
Jay– well said.
This week’s 8-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.
For your convenience, here is the link to login to the premium site:
NOT A PREMIUM MEMBER? Check out this link:
Alan and the BCI team