Another Strategy for P&G Stock
Almost 25 years ago when I was new to P&G, I started dabbling in options after reading a book on the subject. The word “option” can be scary. It conjures up highly speculative strategies. For those of you who know me well, I pay off debt as soon as possible, drive cars that are most economical (I love my Chevy Volt!), and get a little rush when I use a coupon at the store. It won’t surprise you to know that speculative strategies aren’t my thing.
However, the concept of being able to generate income (in addition to the dividend) from a position in a stock can be very interesting. There is an options strategy that fits the bill, called a “covered call.” My experience with covered calls has grown and now that I am in the financial business full-time, I’m spending a lot more time with this approach.
What is a covered call? I will explain it here in short order, and if you want more details, give me a call (I will also post a video on our website). I will admit, it’s very hard to explain in print. I feel like I need to draw it up on a white board. In any case, here goes…. The overall gist of covered calls is that you are willing to sell a stock you already own, at a set price to a buyer, anticipating that its value will increase. Almost like offering a buyer a deal on your stock, betting that its value increase will be profitable to both you and the buyer. Selling your stock in the marketplace this way uses a call option. A call option is a neutral to bullish bet on the underlying stock. When I sell the call in the marketplace, the buyer of that call pays me. That person now has the right to buy the stock from me at a certain price for a certain period of time, before a set expiration date. [Here is the link to the video: https://youtu.be/yS3hjRUPkK4]
Let’s use an example. Say I own 500 shares of P&G stock at $130/share on January 31st. The market provides me with a choice of option selling prices as well as expiration dates to sell within. I chose to sell my option at $139 to expire on February 12th. I took into consideration a realistic selling price within that short time to have the most likely upside. The stock volatility, the selling price you choose, and longer expiration dates can all determine the rate of your upside or risk in being profitable. The marketplace determined that selling this particular call would net me $.25 * 500 shares = $125 (cash deposited to my account). If P&G sells for less than $139 through February 12, I keep the $125, or about .2% of my total investment. As soon as that option expires, I can sell another call, repeating it every couple of weeks and generating income on the P&G stock I own (in addition to the dividend). What’s the catch? Well, if P&G rises above $139 before February 12th, I have capped my upside at the $139 because I’ve agreed to sell the shares to someone else at that price. So, if P&G were to rise to $145, I would be losing out on $5 of gains. In putting the strategy into practice on my own account, I’ve continually sold calls far enough above the current price that I’ve generated the additional income without having to sell the stock. In my example, the stock would need to rise more than $9 (almost 8%) in about 2 weeks for the stock to be sold. And of course, if the stock rose above $139 and I sold the stock, I could always put an order in to buy it back.
In selling covered calls, you may be wondering about taxes and transaction costs. Yes, taxes matter, so I would recommend this as part of a financial plan in a retirement account. And five years ago, this strategy would have been difficult to execute due to transaction costs. Today those costs are near zero.
As we always suggest at Kellett Schaffner, a covered call strategy should be part of a larger financial plan. Give me a call, email, or text if you would like to discuss further. Oh, and follow our Twitter account (@KSWealth) for more information.
Jared
Brian Kellett, brian@kellettschaffner.com. Phone 513-312-6067
Dave Bodnar, david@kellettschaffner.com. Phone 513-258-6973
Jared Kline, jared@kellettschaffner.com. Phone 513-768-2238
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