Early assignment of our covered call positions is rare but possible. When it does occur, it is frequently related to an ex-dividend date. These are dates that we must own the shares in order to be eligible to receive the dividend on the distribution date. Premium members can access ex-dates of the eligible stocks in our Premium Stock Reports in the column on the far right as shown below:

Ex-Dividend dates from the Premium Report

 

In the two rows highlighted in brown we see:

  • GLW (top) has an ex-date of 5/26/2017
  • MGM (bottom) has an ex-date of 6/7/2017
  • Both ex-dates fall within the June 2017 monthly contracts

 

When should we write the calls if we want to avoid potential early exercise of shares we want to hold?

The BCI guidelines are to write the call the day of or the day after the ex-date when that ex-date falls within the first week of a monthly contract or to sell a 2-month option if the ex-date falls in the latter part of the monthly contract. The rationale for this is that the time value erosion (Theta) of an option is logarithmic in nature for near-the-money strikes which means that the longer we wait to sell the option, the less premium we receive. This is seen graphically in the chart below:

best time to execute covered call trades

Time Decay of Near-the-Money Strikes

 

Time decay and Monthly contracts

There are 26 calendar days in the June 2017 contracts. If we wait to sell the covered call on the ex-date of these two securities, the percentage of calendar day time decay lost is as follows:

  • GLW: 6/26 = 15.4%
  • MGM: 17/26 = 65.4%

MGM is impacted even more than the percentages reflect because more time value is lost the closer we get to expiration Friday.

 

Best time to execute covered call trades based on these ex-dates

  • GLW: 5/26/2017 or the next trading day
  • MGM: Write a 2-month call (July expiration) after expiration of the May contracts, thereby moving the expiration date far away from the ex-date, making early exercise highly unlikely (although possible).

 

Technical versus practical application

From a technical perspective, call holders are better off selling the call, buying the stock prior to the ex-date and then capturing the dividend (assuming there is a time value component to the option premium). However, most retail investors will still exercise the option to capture that dividend so all call writers who want to retain the underlying must take these position management strategies seriously.

 

Discussion

For many of us, early exercise is not a problem. It results in maximum returns for the current trade and having our cash back early to then re-invest. But for some, retention of current shares is important and so circumnavigating ex-dividend dates must be mastered. If the ex-date falls in the first week of the contract, we can write the call on that date of the next trading day and still generate decent premium for that month. If the date comes later in that contract month, writing a 2-month call after expiration of the previous month’s contracts is the better approach. Selling Weekly options, when available, is another way to circumnavigate ex-dates and avoiding the covered call position the week of the ex-date.

 

Market tone

Global stocks set record highs during the week., against a backdrop of solid economic and earnings growth. The price of a barrel of West Texas Intermediate crude oil moved to $54.60 this week. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), declined to 9.14 from 10.8 last week. This week’s economic and international news of importance:

  • Donald Trump nominated Jerome Powell to replace Janet Yellen as Federal Reserve Board chair. Powell has been a member of the Fed Board of Governors since 2012. If confirmed, he is expected to maintain monetary policy continuity while rolling back some post–financial crisis banking reforms
  • The US economy created 261,000 new jobs in October. The bounce-back was somewhat smaller than economists had forecast, falling short of the 310,000 consensus view
  • The unemployment rate fell to 4.1%, a 16-year low
  • Average hourly earnings disappointed, coming in unchanged versus the prior month, and rising at a 2.4% rate year over year, down from 2.8% last month
  • Corporate tax cuts make up the centerpiece of the tax reform proposal unveiled this week by Republicans in the US House of Representatives
  • The Bank of England’s Monetary Policy Committee hiked its policy rate from 0.25% to 0.5% this week, the first increase in more than 10 years
  • The Federal Open Market Committee left rates unchanged at their November meeting but hinted that a rate hike remains likely at its December meeting
  • The Conference Board’s consumer confidence index rose to the highest levels since December 2000
  • With nearly 80% of the S&P 500 Index having reported, third-quarter earnings are expected to increase 5.9% compared with the same quarter a year ago
  • The growth rate rose to 8.5

THE WEEK AHEAD

Mon Nov 6th

  • Eurozone, UK: Service sector PMI and investor confidence index

Tue Nov 7th

  • Australia: Rate-setting meeting
  • Eurozone: Retail sales

Wed Nov 8th

Thu Nov 9th

  • US: Wholesale inventories

Fri Nov 10th

  • UK: Industrial production and trade balance

For the week, the S&P 500 rose by 0.26% for a year-to-date return of 15.59%

Summary

IBD: Market in confirmed uptrend

GMI: 6/6- Buy signal since market close of August 31, 2017

BCI: My portfolio makeup reflects a slightly bullish bias, selling 3 out-of-the-money calls for every 2 in-the-money calls.

WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US

The 6-month charts point to a slightly bullish outlook. In the past six months, the S&P 500 was up 9% while the VIX (9.14) moved down by 15%.

Much success to all,

Alan and the BCI team





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