The holiday season is upon us once again.
While Thanksgiving is one of my favorite holidays, it was always a pain when I was working. I never agreed with the stock market being open on the Friday after Thanksgiving even if it’s a half day. Most people took that day off. Clients were with family. Trading action was typically light.
Since the stock market was open, I had to be aware of what was going on with the markets and with clients. The Friday after Thanksgiving was easily the worst day to have to be in the office. In my later years I took that Friday off and placed my trust in the hands of my assistants on holding the ship together. I was still “on call” in case something serious came up during the shortened trading period. My Thanksgiving holiday was never truly relaxing.
As a retiree, I savor the fact that I can enjoy Thanksgiving with my family without work and market related distractions. There is a tremendous difference in the meaning of a holiday in retirement.
The Double Income Investment Strategy, Part 3
In the last article, I mentioned an Exxon (XOM) trade I recently made. My old XOM shares had been assigned on Exxon’s ex-dividend date. Since I still liked the stock at current levels, I had rebought XOM at $82.50 and sold June $87.50 strike covered calls for $1.59. I’m going to miss out on the $0.77 per share dividend when it pays in December, but I collected $1.59 per contract right away.
This assignment was largely expected because the strike price was at $80 and the stock price before ex-dividend day was around $82 and the option expiration was in December.
XOM data by YCharts
For this final part of my series of the Double Income Investing Strategy, I will cover the remaining parts of the strategy that I am mindful of.
One of the biggest concerns investors have when selling covered calls is having their option assigned and the stock being sold out of their account. I would guess that the majority of these folks are growth investors.
As a reminder, the Double Income Investment Strategy focuses on the gathering of income, primarily in a tax advantaged account. This income comes from dividends and option premiums. This strategy is not intended for those who focus on growth in their portfolio. As an income investor, covered call option assignment is not a concern for me. It is an opportunity.
I’ve mentioned time and again in my past articles that I am retired and I only want to make income from my portfolios and the sooner the better. I use this income for retirement expenses. Also being a retiree, I want to spend a minimal time working on my portfolio and most of my time enjoying my retirement time with family and friends, relaxing, and giving back to others and more.
Many covered call option investors know that if the current stock price is higher than your covered call strike price, your options could be assigned at any time and the holding can be sold out of the account at the strike price. However, there are some interesting things to know about option assignment.
From my experience, there are two key times that covered call options will be assigned. I’ll call them early assignment and natural assignment.
Early assignment almost always occurs on the night before the ex-dividend date. This is because the option buyer wants your dividend. By initialing the assignment, she will own the stock on ex-dividend date instead of you and she will collect the dividend. Natrually, the stock price needs to be greater than the strike price by the end of trading the day before the ex-dividend day.
The more time there is until to option experation, the less likely a stock will be assigned – even if the option is in the money. Conversly, the closer the option is to expiration, the greater the chance your option will be assigned.
Using the trade above, I have covered calls at the June $87.50 strike which is about 7 months away. Even if XOM stock got to $90 by the next ex-dividend date, the chances of assignment are remote due to the amount of time to option expiraton involved.
On the same trade, if XOM was trading for $90 right before the last ex-dvidend date before the covered call option expires, the chance of assignment is almost certain because less time is involved.
In a natural assignement, if the stock price is greater than the strike price on option expiration day, your option will be assigned. I have seen stock assigned even if the stock price on expiration date was even a penny above the strike price by the end of the day’s trading.
Those are the two main times your covered call options will be assigned. While it is possible for an in the money option could early assigned in another instance, I would consider that to be very rare occurrence for a blue chip stock.
As a retiree who invests for income, option assignment does not worry me. If anything, it creates a liquidity event that I can repurchase the same stock if it still trading at a discount – like with my Exxon trade. Or I can use the freed-up cash to hold or to invest in another stock that is trading at a discount.
Missing out on a dividend is also not a big deal to me. In the case of Exxon and many other blue chip stocks, the option premiums are much greater than the dividend. Whether I reinvest in the same stock like I did with Exxon or invest in another company, the option premium I collect will be greater than the dividend I would have received. Often the option premium is 2x a dividend when you go out 9-12 months. Plus, instead of waiting a month or so to get that dividend payment, I’ve already collected he option premium, many times a business day or so later.
Lastly, do not forget that for your option to be assigned, the stock price needs to be above the strike price. In the case of the Exxon trade, I bought the stock at $82.50. If the stock price gets to $87.50, I get a $5 per share capital gain, plus the option premium, plus all dividends collected.
Covered Call Buyback
The final thing I want to cover in this series is the covered call buyback. After I make my trades, for the most part I leave them alone and let them run their course. There are exceptions.
One time I pay special attention to a holding is on ex-dividend day – especially if the stock is in the money. This is because if the stock gets assigned, the liquidity event creates an opportunity for me.
Another time I pay special attention to a holding is after the covered call expires worthless. Once again, opportunity presents itself to sell new covered calls on the position.
The one other major time I keep a close eye on a holding is when the time to option expiration is growing short and the stock price of the holding is below the strike price. This is when the price of the covered calls come into play.
Consider the Exxon trade above that expires in mid June 2018. While XOM’s stock price will bounce around in different directions over time, let’s pretend the stock price of XOM is still around $82.50 in April of 2018. With over 5 months of time decay and $5.00 out of the money, the covered call options I sold for $1.59/contract would probably be going for $.20 cents.
With two months still remaining until the options expire, and the covered calls are only worth 20 cents a contract, I could do nothing for those remaining 2 months and the options might expire worthless. Or, I could buyback those options at .20 per contract.
At this point, my thought would be to buyback the covered calls with the intention of selling new covered calls going out 9-12 months. In this case, I would be giving back .20 from the $1.59 I originally collected and then gain another $1.50 or so. In the meantime, I’ve saved about 2 months of time and realized my income faster. More importantly, a lot of things could happen in the final 2 months that remain. The stock could bounce up to $90 a share for all I know and I would miss out on the extra income from reselling the covered call options.
A similer situation is if the covered calls that I sold were going for pennies on the dollar with any significant time until expiration. If I can make a case for buying back covered calls on the cheap with a month or more to expiration and then selling new covered calls 9-12 months out for near 2% premium, then I would make the transaction – over and over again as my positions allowed for it.
I consider the removal of any kind of uncertainty from your investing an advantage. Buying back covered calls early and when they’re cheap, eliminates the uncertainty of what will happen to a stock in the future. In the Exxon trade situation, it’s 2 months of uncertainty – removed.
The two factors of option assignment and buying back covered calls are very important parts of the Double Income Investment Strategy. Both of these factors are things to look out for after doing a trade. Both of them present the investor with opportunities. Fortunately, these factors do not require constant attention because the covered calls I write are 9-12 months out.
In retirement, I like being able to keep one eye on my investments every now and then and the majority of my life enjoying life and all that retirement living has to offer. The main things I keep an eye on after the trade is done is ex-dividend dates, and the value of the option as it decreases in time, and when tor option expires. All of these present opportunities to the income investor.
This concludes my first and probably only article series. It is difficult to write articles on here on some sort of constant basis. There are just so many things to do with your retirement time. I enjoy writing, but it is not a job for me. As I have mentioned before, I write on here as a way of sharing what I know and as a way for me to give back to others. I mention this because I see some contributors shooting out multiple articles a week! I applaud their efforts, but that’s not for me. I will continue to write on here, but I cannot promise to submit a regular piece every single week. That being said, my next article will go back to stocks.
My goal of this series was to explain the Double Income Investment Strategy as in-depth as I could because my retirement income investing is based on this strategy. I hope this three part series was educational. In future articles, you’ll see different parts of this strategy at work.
Thank you for reading and for following me.
Have a wonderful Thanksgiving holiday everyone!
Disclosure: I am/we are long XOM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for the author and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.