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Investing with Options - Microsoft Covered Call
Koen Hoorelbeke
Investment and Options Strategist
Summary: The financial markets are filled with activity this week, with significant news events such as the Federal Reserve's interest rate decision and jobless claims on the horizon. Additionally, earnings reports from major tech companies and other market players, including Microsoft, Google, Amazon, Visa and many more are expected. This article explores a covered call strategy that can be used to optimize the yield of existing Microsoft positions
Anticipation is high for Microsoft's earnings report. The stock has experienced a remarkable rally over the past few months. Just last week, the announcement of a $30 monthly charge for its upcoming Copilot AI-service propelled the stock to over $360, before it settled back to around $344.
This price fluctuation has resulted in high volatility for Microsoft's stock. Its current Implied Volatility (IV) rank stands at 58.60%, with an IV percentile of 82%. This indicates that the stock's volatility was lower 82% of the time over the past year.
If you hold Microsoft stocks, you can enhance your yield by selling covered calls. For every 100 stocks you own, you can sell one call contract, thereby earning additional premium. The following is an example of such a covered call strategy.
Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.
This trade setup is a Covered Call strategy on Microsoft Corporation (MSFT). Here's a breakdown of the trade:
1. Underlying Asset: The underlying asset for this trade is Microsoft Corporation (MSFT:xnas). The last traded price of MSFT was $343.77 last Friday, July 21st 2023.
2. Covered Call Strategy: The strategy involves selling a call option while owning the underlying asset. This is known as a covered call strategy. The goal is to generate income (the premium received from selling the call) while potentially selling the stock if the price rises above the strike price.
3. Option Details: The call option being sold has a strike price of $360 and expires on August 11, 2023. This means that if MSFT's price is above $360 on the expiration date, the option can be exercised, and you would have to sell your Microsoft shares for $360 each. However, if you don't want to sell your shares and the price is above the strike price as the expiration date approaches, you have the option to "roll" your position. This involves buying back the current call option and selling another one with a later expiration date, and possibly a higher strike price. This can generate additional premium income and give the stock more time to potentially increase in value.
4. Premium: The premium received from selling the call option is $620. This is the income generated from the trade, which you get to keep regardless of what happens with MSFT's price.
5. Breakeven Point: The breakeven point for this trade is $366.20. This is calculated as the strike price plus the premium received divided by the number of shares. If MSFT's price is above this level at expiration, the trade will be at its maximum profit.
6. Risk: The maximum risk in a covered call strategy is if the stock price falls significantly. However, the premium received from selling the call option provides some downside protection.
7. Calculating the yield:
The yield from the premium can be calculated as a return on the capital invested in the underlying shares. Here's how you can calculate it:
1. Capital Invested: The capital invested in the underlying shares is the price of the shares multiplied by the number of shares. In the case of 1 call contract, it's 100 shares at $343.77 each, so the capital invested is $34,377.
2. Yield: The yield is the premium received divided by the capital invested. In this case, it's $620 / $34,377 = 1.80%.
However, this is the yield for the 18-day period until the option's expiration. If you want to annualize this yield to compare it with other annual returns, you can do so as follows:
Annualized Yield: To annualize the yield, you first calculate the number of 18-day periods in a year, which is 365 / 18 = 20.28 periods. Then, you multiply the yield for one period by the number of periods in a year. So, the annualized yield is 1.80% * 20.28 = 36.50%.
So, the yield for this covered call strategy is 1.80% for the 18-day period, or 36.5% on an annualized basis.
Please note:
- this is a simplified calculation and actual results can vary based on a variety of factors.
- selling covered calls can generate income, but it also caps your upside potential because you may have to sell your stock if its price rises above the strike price. It's important to be comfortable with this trade-off before implementing a covered call strategy.
- If you possess a definitive outlook on the trajectory that MSFT will take, initiating a trade before the earnings announcement could be a profitable move. This is due to the heightened implied volatility, which results in a higher premium to collect. However, if you're uncertain, it might be prudent to hold off until just after the earnings are released and then contemplate new strike levels. While you may lose some options value due to the volatility slump, if Microsoft experiences a significant "gap-up", you could find yourself in a more secure position.
This strategy can be a good fit for investors who are bullish on Microsoft in the short term and are looking to generate additional income from their investment. As always, it's important to consider your risk tolerance and investment goals before implementing any new strategy.
Options are complex, high-risk products and require knowledge, investment experience and, in many applications, high risk acceptance. We recommend that before you invest in options, you inform yourself well about the operation and risks. In Saxo Bank's Terms of Use you will find more information on this in the Important Information Options, Futures, Margin and Deficit Procedure. You can also consult the Essential Information Document of the option you want to invest in on Saxo Bank's website.
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