deep in the money calls 19, 3% Per Month With Halliburton (HAL)

Targeting a 3% per month return with covered calls is aggressive and not easy to achieve for several months in a row. Usually the covered calls that offer that kind of return suffer from the anticipated volatility of an earnings or FDA announcement prior to option expiration.

But every once in a while there is a special situation where the risk/reward is more balanced. Currently, Halliburton (HAL) is one such opportunity.

Juicy Call Premium Plus A Dividend

Halliburton made an offer to buy rival Baker Hughes (BHI) last week. The premium to BHI's stock price that HAL offered caused HAL's stock to drop from 55 to just over 48. It's been 3 trading days since the news came out and it looks like most of the selling is done. The additional fact that HAL has an 18 cent dividend that goes ex-div on Dec 3 sets up a nice opportunity for an in-the-money covered call with dividend capture.

3% Per Month With HAL

There are a couple of ways to earn 3% in a month on HAL right now. Today (Nov 19) HAL closed with a bid-ask spread of 48.44 x 48.50. Because there is an ex-dividend date of Dec 3, let's look at the Dec 5 weekly option expiration for a covered call (by setting the expiration date after the ex-div date we will get the dividend as well as the call premium):

Expiration Strike Call Bid Buy Stock, Sell Call
(aka Net Debit)
Return If Flat Annualized
Return If Flat
Dec 5 48 1.73 46.77 3.0% 64.4%

The returns assume you will receive the 18 cent dividend and then have the stock called away for $48/share. If that happens you will make $1.23 in time premium (calculated as the 48 strike minus 46.77 net debit) plus 18 cents in dividend, for a gain of $1.41/share in 17 days (and 1.41 / 46.77 = 3.0%).

However, because the ex-div date (Dec 3) is so close to the expiration date (Dec 5), it is possible there will be an early exercise of the option. If that happens you will still make money, just not quite as much as if you had received the dividend, too.

To reduce the risk of early exercise, and also to trade in an option series that has much higher open interest, let's look at the monthly Dec 20 expiration:

Expiration Strike Call Bid Buy Stock, Sell Call
(aka Net Debit)
Return If Flat Annualized
Return If Flat
Dec 20 47.5 2.51 45.99 3.7% 43.6%

This one has even more downside protection (since the strike is 47.5 instead of 48), which is good for you, and a higher Return If Flat (3.7% vs 3.0%). However, the Annualized Return If Flat is lower because the holding period is longer (31 days vs 17 days). Still, earning 3.7% for a 31 day trade where you have more than 5% downside protection is not a bad deal (the downside protection is because your break even point is lower than the current stock price). If the stock is not called away at 47.50 on Dec 20 then you will own it at an adjusted basis of 45.81 (net debit minus the 18 cent dividend).

Several Ways To Win

Okay, so the numbers look good. But what about the investment quality? Is HAL a stock you should own? What could cause HAL to stay flat, or even go higher?

There are at least 3 things that would most likely cause HAL stock price to rise:

  1. The BHI deal does not go through. In this case HAL should recover the 10% drop it experienced when it made the offer.
  2. The BHI deal does go through and the anticipated synergies are realized. This will appear as increased earnings eventually but could take several quarters to materialize. (Of course, you can write calls and collect dividends while you wait.)
  3. The price of oil could stop going down. Some day the price of oil will go up again and when it does companies like HAL should be well positioned for increased earnings.

While we do not make trade recommendations, the Dec 47.50 covered calls on HAL look like an interesting way to make over 3% return in 31 days. Do your own homework, keep your position size appropriate, and happy trading.

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