Continuing my series summing up my covered calls done for October expiration, the last trade done was against Eastman Kodak (EK).   I found EK as a result of using TradeKing’s option strategy screener, where the primary filtering criteria was to stay within the limits of the unallocated cash within our GI portfolio, and secondary criteria where profitability vs. risk analysis.

From the old days...

TradeKing’s option strategy screener is probably not the best tool you’ll ever find, but it is definitely much, much, much faster than screening by hand, and probably helps guide beginners (like me) quite a bit.  The tool’s proper name is the “RT Spread Scanner” and it describes itself as:

“RT Spread Scanner service is a professional tool for scanning equity option universe for profit
opportunities. It covers the most popular strategies, from plain naked or covered strategies and
conversions to more sophisticated spreads, straddles and strangles. Intuitive, but flexible interface
makes the service suitable for both novice and advanced users.”

One of the nicest things I like about it is that while it launches from a browser window (It’s a Java applet), you can save, as local files, your screening configurations and results and then re-load them next time you need to launch the app.  Perhaps it is just that I haven’t used enough of these tools before and all brokerages offer such a thing?  But it sure is better than reconfiguring Yahoo and Google screeners each time.

That being said, I forgot to save the configuration I used when I found EK.   But as an example of what’s possible, here’s one I might use in the future:

1. Set to use a short covered call strategy.  (Short means selling the call.)
2. Show top 50 hits sorted originally by Risk/Reward ratio.  (“Less risky means low max risk to max profit ratio” and “We calculate 2 STD for profit and 2 STD for risk at expiry and use these as proxy for max loss / profit.”)
3. Scan only DJIA stocks.
4. Look only for options with next month’s expiration.
5. The option strike should be near ATM, that is within +/- 10% of the latest trade.

The one critical thing missing from that list that helped me find EK was setting a filter for initial capital required and the number of options to plan for.  Obviously, I had 1 option and a fairly low capital requirement.  After manually screening the top 15-to-20 or so results (many of the top 50 were repeats of the same underlying with different strikes), I settled on EK as a good combination of risk vs. reward.  In the end though, because the stock was trading so cheaply, I was able to do 3 contracts instead of just 1.

Here’s a summary of the trade we completed.  As usual on this blog, I’m including the commissions I have been, or a forecast of what I will be, charged in these numbers and thus the values go out to fractions of a cent.

Critical Dates:
2009.09.25: Initial position: BTO 300 EK @ $4.9265
2009.09.25: Initial call option: STO 3 EK JA (Oct09 $5) @ $0.306967

Summary, if NOT called (static return):
Days position held: 22
Capital investment: $1477.95
Income received: $92.09
Percent return: 6.23%
Annualized yield: 172.60%

Summary, if CALLED at expiration:
Days position held: 22
Capital investment: $1477.95
Net profit if called: $109.19
Percent return if called: 7.39%
Annualized yield if called: 226.27%

I can’t say that I have a super strong feeling about the long term prospects of Eastman Kodak.  It has recently had a nice run-up that appears to have peaked, and I may end up riding downward.   Given the lowered capital involved, this seemed like a good way to force myself into exploring things that don’t cushion my mistakes by shooting upward.  A forced learning experience, if you will.  On the other hand, if it turns out well, its a pretty damn nice APY.

Continuing from yesterday’s post, I’m now discussing the second trade completed this past Friday, part of three trades I’ve done for the October expiration period.   In this case, I’d discovered that the premiums on AIG were huge, and that meant getting a decent profit while still being cautious.  But was I too cautious?

High volatility: pretty much like a roll of the dice?

At the time of my research, AIG was trading at about $43.60 and the at-the-money call bids were over $5.  That is over a 10% instant return (or 400% APY), but remember these premiums are so high because there’s alot of volatility on AIG.   That volatility is much, much higher than anything else I’ve looked at in my covered call experiences.  For example, during the last 30 days AIG has been as low $34 and as high as $54, and that’s a wide range indeed.  A $4 premium would only prevent losses down to the mid $39s, which isn’t exactly outside the trading range, so it still seems pretty risky to me.  Is the reward worth the risk?

At this point, I kept researching because I had a goal for this period which was to expand my experiences with options and covered calls.   On the one hand, this trade would be done within my GI portfolio which is kind of “side” money.  I’m not yet relying on it for retirement or anything else critical to my family’s well being.  Yes, I’d not be thrilled to lose money, but I want to force myself to learn and I’ve already discovered I do that best when I’m watching a position I’m involved in.

However, I still wasn’t comfortable with the amount of risk involved with an at-the-money position.  So in playing around with different strikes in my spreadsheet, I realized that there were still decent returns to be made even when entering with pretty low strikes.  In effect, I’m trading upside for more downside protection.   After talking over a number of scenarios with my wife, we decided that a trade with a 100% APY and protection down to $35 had an acceptable risk/reward ratio.  That’s a 100% return on our capital where we won’t lose money unless the underlying drops by more than 20%.

Here are the details of the trade actually made.  As usual, I’m including my actual commissions which is why some values go out to fractions of a cent.

Critical Dates:
2009.09.25: Initial position: BTO 100 AIG @ $43.7095
2009.09.25: Initial call option: STO 1 IKG JK (Oct09 $37) @ $8.7037

Summary, if NOT called (static return):
Days position held: 22
Capital investment: $4370.95
Income received: $870.37
Percent return: 19.91%
Annualized yield: 1934.41%

Summary, if CALLED at expiration:
Days position held: 22
Capital investment: $4370.95
Net profit if called: $194.47
Percent return if called: 4.45%
Annualized yield if called: 105.90%

By the way, TradeKing’s probability prediction tool pegged the chance that AIG is above our $37 stike price at expiration as just over 90%.  Unfortunately, I’m not sure how they’re doing that calculation.  Is it historic volatility?  Implied volatility from market inputs?  Some combination of the two?  I’ll need to try to figure this out.  If anyone knows, please don’t hesitate to comment.

While I’ve done this trade at $37, a part of me really feels like I should have been more aggressive.  There is currently a clear upward trend on AIG since early August.  And a bet on that continuing could earn some significant returns.  For example, a covered call using a $49 strike could have earned $821 if it got assigned.  That’s a 1,620% APY!   Even moving the strike up just a few dollars to $39 would have returned an annualized 200% plus.

Am I thinking about the possibilities with AIG correctly?  What would you have done in a similar situation?  Please let me know what you think.

Last Friday, I initiated three new covered call trades using our GI portfolio.   I’m getting more and more nervous that we’re going to have a downward correction soon, but I decided to gently push things one more time for October expiration given that it was only 3 weeks away.  I also decided to purposefully try exploring a few different situations in making covered calls.

How many of these can Intel "flip"?

The exploration decision really came about because I came up empty after doing my now typical scan for a Dividend Aristocrat or Dividend Achiever that was likely to pay a dividend prior to October expiration.  The time premiums on everything that fell out of my screen were just quite low, with quite a few coming under a 1% return for near-the-money calls.  I didn’t find anything over a 2% return that also didn’t have a huge spread between strike prices, i.e. anything where I felt the gap could be overcome by expiration, or where the premium from the call decently covered the fact that I’d have to sell the underlying for less than I had bought it at.

On the one hand, I took this as a sign that the market thought prices weren’t going to move much over the next 3 weeks.  After all, option prices are related to volatility, so if prices are low than the market is predicting volatility to be low too.  Thus, I should perhaps tame my worries about a near-term correction.  But then I had two following thoughts.  First, most of these stocks I was looking at had fairly low options volume, so it’s quite possible the pricing numbers I was seeing were skewed from reality.  Second, why should I blindly trust the market consensus?  Perhaps the low premiums are a sign that, as a newbie, I should sit this month out and see what happens?

On the theory that I learn best by having some skin in the game, I decided to search elsewhere, but keep my bias toward being conservative.  I next checked over at the latest week’s posting on ETFCoveredCalls.com but didn’t find anything I felt too good about trading there.  For one thing, I was looking prior to the weekly Friday post and thus looking at things at least a week old.   Second, I’m still not feeling comfortable with most of the leveraged ETFs, nor with a number of sector ETFs, and these are what make up the majority of the top listings.

Instead, I decided to try my hand at searching through the tech industry for opportunities, starting of course with some of the larger companies in that space.  It didn’t take long until I found myself being interested in a situation with Intel.  This was primarily due to my own feelings about how the industry is doing recently (I work in tech), analyst forecasts of INTC increasing EPS for the rest of 2009, corresponding analyst buy recommendations, a forward P/E exactly at industry standard, and a lack of much tech exposure in our other portfolios.   All of which balanced out some of the volatility the market is forecasting, thus helping me feel confident that INTC could bridge the few dimes to the next strike.  And stay above that mark at Oct expiration.

Here’s the summary of the trade so far.  As usual, I include the commissions I’m paying at TradeKing and thus some numbers go out to fractions of a penny.

Critical Dates:
2009.09.25: Initial position: BTO 100 INTC @ $19.5195
2009.09.25: Initial call option: STO 1 NQ JD (Oct09 $20) @ $0.4139

Summary, if NOT called (static return):
Days position held: 22
Capital investment: $1951.95
Income received: $41.39
Percent return: 2.12%
Annualized yield: 41.64%

Summary, if CALLED at expiration:
Days position held: 22
Capital investment: $1951.95
Net profit if called: $84.49
Percent return if called: 4.33%
Annualized yield if called: 101.99%

Keep in mind, because I’m still leaning conservatively, I’m not swinging for the fences here (at least I don’t think I am,) but instead am looking to capture a decent gain while minimizing losses.  Thus I didn’t go for a higher strike on INTC, where I’d end up with a higher cost basis as well.   With my entry, I’ve actually lost nothing (but commissions) if I can get out before INTC drops below $19.11.   While this means I need to watch INTC fairly closely over the next 3 weeks, I’m also investigating how to place triggered trades at TradeKing to see about buying back the call.  It looks like I can easily place a contingent order on NQ JD’s ask dropping below a threshold I set, but I can’t seem to figure out how to have that trade also trigger a STC of the underlying.

This month, we had three open option positions waiting for September expiration, which was this past Saturday.  I was still out on vacation then, so I’m just checking on things now.  A quick login to TradeKing shows that we’re back to all cash, so clearly all three positions got assigned – our desired result.

Learning to use options for income

This is our desired result because our goal has been to identify short-term covered call opportunities that generate the best return we can find given our feelings of acceptable risk.  The keyword there being short-term.  We want to have our calls assigned so that each month we can identify the next best opportunities.  This idea is predicated on the decay of the time value of call options where the greatest rate of change in value is during the last few days of the option’s life.  This means a call seller can make the most profit by buying just before that time and waiting for either expiration or assignment.  However, because expiration happens only one time a month you can’t just sell calls every few days that expire in days.  The best you can do is sell next month’s call as soon after this month’s expiration as possible, i.e. sell to capture the most premium and hold during the shortest possible period that includes the time of rapid value decline.

So how did we do with September expiration?  Here’s my summary of the round-trip trades we’ve just completed.  As always, I’m including my commissions I paid to TradeKing, which is why some numbers go out to fractions of a cent per share.

AA & AA IO: Critical dates

2009.07.21: Initial position: BTO 200 AA @ $10.65475
2009.07.21: Sold call option: STO 2 AA HL (Aug09 $11.00) @ $0.3387
2009.08.03: Call roll: BTC 2 AA HL / STO 2 AA HO (Aug09 $13.00) @ $1.33255
2009.08.22: Call expiration: 2 AA HO @ $0.00
2009.08.27: Sold call option: STO 2 AA IO (Sep09 $13.00) @ $0.2187
2009.09.19: Assignment: STC 200 AA @ $12.9749

AA & AA IO: Summary

Days position held: 60
Capital investment: $2397.46
Net Profit: $315.00
Percent return: 13.14%
Annualized yield: 111.90%

CNO & CNO IH: Critical dates

2009.08.27: Initial position: BTO 200 CNO @ $4.25475
2009.08.27: Sold call option: STO 2 CNO IH (Sep09 $4.00) @ $0.4987
2009.09.19: Assignment: STC 200 CNO @ $3.9751

CNO & CNO IH: Summary

Days position held: 23
Capital investment: $850.95
Net Profit: $43.81
Percent return: 5.15%
Annualized yield: 121.82%

SVU & SVU IC: Critical dates

2009.08.26: Initial position: BTO 200 SVU @ $14.76475
2009.08.26: Sold call option: STO 2 SVU IC (Sep09 $15.00) @ $0.2387
2009.08.28: Dividend: 200 @ $0.175
2009.09.19: Assignment: STC 200 SVU @ $14.97485

SVU & SVU IC: Summary

Days position held: 24
Capital investment: $2952.95
Net Profit: $124.76
Percent return: 4.22%
Annualized yield: 87.64%

As an overall summary of our covered call experiences, keep in mind my wife and I sold our first covered call back on July 6th, we’ve earned a return of $782.84 on a total investment of $5,722, or 13.68%.   Since it’s been 80 days exactly between July 6th and today, that gives us an annualized yield of 79.51%.   Much, much better than we could have earned in a CD or savings account.

On the other hand, this has been done during a period where almost all stocks are acting like little boats on a vast rising tide.  We definitely could have done better if we’d simply bought the stocks outright and held them for the same periods of time (i.e. month long periods.)  While that fact could be emotionally depressing, I’m choosing to look at this as a very forgiving time to learn to do options trading so that we’ll be able to earn income even if the market isn’t shooting up.

I’m just back from a 3-week vacation/camping trip without internet access, and am now catching up on finances.  One of the first things I note is that ING Direct dropped the yield on the Electric Orange savings account to a 1.30% APY on Sept 9, 2009.  This prompts me to do a quick survey of online savings account rates.

http://www.sxc.hu/profile/svilen001

Before I get into that though, I’ll note that ING’s change is a drop of 0.10% from the previous APY of 1.40%, which had been in effect since July 3, 2009.  As a point of interest, at this point last year ING Direct’s EO savings had a yield of 3.00% APY (which I can tell from my account history.)  Also, as far as I can tell, this is the lowest rate ever for the EO savings, though I can’t quite be positive of that since our account history doesn’t go quite as far back as the history of this product being offered in the US.

In alphabetical order, here are the current rate’s offered by some traditional high rate online savings accounts:

• Ally High Yield Savings: 1.75% APY
• Dollar Savings Direct MMA: 1.70% APY
• FNBO Direct OSA: 1.50% APY
• HSBC Direct MMA: 1.45% APY
• ING Direct Electric Orange: 1.30% APY
• WT Direct Savings Account: 1.66% APY

From a quick check over at BankRate.com, the highest nationally advertised rate as of today is 1.85% APY over at UFBDirect.com.   Though I note Ally comes in at the third highest, which still makes me feel good since my wife and I switched to using them for much of our cash and emergency fund CDs a few months ago.