Monday, October 19, 2015

Option Trade

   I recently wrote about a stock purchase in Restaurant Brands International, that you can read about here.  The yield on this stock is low, so I was looking for a way to gain some cash flow from this investment.

   One of the ways to receive cash flow from a position that you own is to write a covered call.  With a covered call, the seller receives a premium for the promise to sell his or her shares at the strike price  on or before expiration.  A covered call is sort of like "renting" you stock.

    If the price of the stock goes down or sideways, the option seller stills get to keep the premium.  The option seller can sell another covered call on the stock if he or she chooses to. Another benefit of actually owning the shares is that the option seller still receives the dividend if they own it on the dividend record date.

     If the price of the stock goes up and the option is assigned,  the shares are "called" away.  If the strike price is about your purchase price, then the capital gain is higher do to the option premium is added to the proceeds of sale for tax purposes.  Depending on which broker you use, there might be an option assignment fee.  In my case, my brokerage as an option assignment fee of $24.95.


     On October 19, Restaurants Brands International (RBI) was trading around $47.00 a share.  I looked at the option tables and saw the bid price was around $1.05 per contract for Nov 20 expiration and strike price of $48.00. So I watched if for about 5 minutes and saw it change to $1.10 per contract. So I placed a market order for 1 contract.

   RBI just paid a dividend at the beginning of October, so there will be no dividend paid between now and expiration as the dividend is quarterly.

Two Possible Outcomes

Scenario #1 - Option assigned

Option assignment fee = $24.95
Option commission = $10.95
Premium = $1.10
Number of contracts = 1
Initial Price = $4700+ $4.95 =$4704.95
Strike Price = $48.00

Profit = $4800-4704.95-$24.95-$10.95+$110.00
          =  $169.15

Total Return = $169.15/$4704.95
                      = 3.60%

Scenario #2 - Option Not Assigned

Premium received including commissions = $99.05
# of days until expiration = 32

Still get to be the owner of the 100 shares.

Return = $99.05 / ($4704.95 -$99.05 )
             = 2.15%

Annualized return = 2.15%/32*365
                              = 24.52%

     A covered call limits the profit that an investor can make but allows the investor to collect some more income from the position.  The price of the stock has risen a lot today since the option was sold. The stock currently trades at $49.28 as of this writing.  The option has not been assigned as of right now.

Note: The shares were purchased on the Toronto Exchange.

Disclosure: Long RBI

I am not a financial planner, financial advisor, accountant or tax attorney. The information on this blog represents my own thoughts and opinions and should NOT be taken as investment or business advice.

Every individual should do their due diligence to make their own financial decisions based on their financial situation and tolerance for risk.

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