KMI Covered Call July 2014

Type: selling covered call
Reasoning: As mentioned on the recent CSCO covered call sale, I also have greater than 100 shares of KMI within my Roth IRA. I have approximately 166 shares generating $279.39 a year in dividends ($69.85/quarter) and KMI next pays its dividend in August. My cost basis is 39.19/share.

In order to reduce my cost basis even further than just buying additional shares, I sold 1 contract of a KMI covered call expiring on September 20th at a strike price of 37.5 for a credit of $64. If the stock drops, stays stagnant, or rises but stays below the strike price, I will have collected $54.29 after commissions and will have reduced by cost basis to 38.65.

If I’m able to do a similar trade every 2 months, collecting around $64 each time, that will bring in an additional $384 in options income before commissions.

If I just hold onto the shares and passively collect the dividends, I will be receiving around $276 a year.

I’ll watch this and might buy back the option for at least a 50% gain if the stock drops more or as a result of theta decay. A bad thing about purchasing the option back is that since I’m doing this in my Schwab Roth IRA account, and not within the dough trading platform from TD Ameritrade, my commissions are substantial for the small amount of money that I’m trading. For example, selling and then buying back this option would cost $19.42 in commissions, while only $3.07 with the great deal going on now in dough.

As you may notice, the strike price of 37.5 is still below my adjusted cost basis of 38.65. My hope is that KMI stays below the strike price by expiration so that I will be able to realize the entire premium (and then sell more calls to reduce cost basis further). However, should it appear that KMI is ready to break even higher, I would be willing to buy back the option for more than the premium.

Why? Well, it is because of something I’m calling “realistic max loss.” The chance of the stock dropping to $0, which would be the maximum loss that I could sustain with (or even without) this option trade, is extremely low. It is much, much more likely that the stock would rise above the strike price.

Should the stock be called away from me at 37.5, I would have realized a loss of $115 on the stock since I would be forced to sell the stock at a price lower than my cost basis. Therefore, by paying up to $115 to buy the option back, I’d be able to hold onto the stock, keep acquiring dividends, and my loss on the trade would be the same either way. It’s something I hope doesn’t happen, but that option is still on the table.

07/02/14 STO 1 KMI Sep20 2014 37.5 Call @ 0.64
Comm = 9.71
Credit: 0.64

This trade could turn out a few ways:

Max Profit $64 – $9.71 = $54.29 Max profit occurs if KMI is less than 37.5 on expiration day, which is September 20. Max Profit = Net Premium Received – Commissions Paid
Max Loss unlimited Max loss occurs if KMI drops to $0. In that case, my long stock position would lose all of its value. However, I would get to keep the premium from the covered call sale so the maximum loss is actually less than if I had not sold the call. Also, if KMI drops a ton I could buy back the covered call for very cheap. Max loss = Premium received – Entire value of long stock – Commissions Paid
Realistic Max Loss $115 Realistic max loss occurs if KMI rises above 37.5 before expiration and the stock gets called away. In that case, if I did not act, I would have sustained a loss of around $115 on my KMI position (39.19-0.5429-37.5). If it does appear that KMI is poised to go higher, I would be willing to pay up to $115 to buy the option back and hold onto the stock. Realistic max loss = Cost basis of Underlying – Premium received – Option strike price + Commissions Paid

Update (7/23/2014): KMI has risen much more rapidly than I anticipated. It is currently up to 37.70 and still has approximately two months until expiration. As mentioned, my breakeven point on the stock is 38.65. If the stock were called away at 37.5, I would have locked in a capital loss. Therefore, I decided to roll the option up to a 40.0 strike at the same expiration date for a debit of 0.73. Therefore, should the stock stay below 40, I would have lost $9 (0.73-0.64). Of course, high commissions in my Roth IRA account would add to this loss.

It looks like my attempt at reducing cost basis by selling a covered call didn’t work so well this time. But, I’ll get to keep collecting dividends and hopefully will be able to sell covered calls on KMI in the future.

07/23/14 BTC 1 KMI Sep20 2014 37.5 Call @ 1.22
07/23/14 STO 1 KMI Sep20 2014 40.0 Call @ 0.49
Comm = 10.47

Update (9/20/2014):
Well, the KMI call option closed Friday at 37.97, way below my new strike price of 40 AND almost at the original strike price of 37.5. Because I rolled the option to a higher strike price on 7/23/14 for a small debit of $9, my loss on this option was a whopping $29.18! Not too bad in the grand scheme of things, but I really do need to try and get my Schwab’s options fees lowered. Commissions accounted for $20.18 of the total loss! That is just unacceptable and will definitely be limiting my purchasing and selling of options on my Schwab account. Had I done the same trade on my TD Ameritrade account, the total commissions would have only been $4.60. TD has been wanting to get me to transfer my Roth IRA over to them so maybe I can use this as leverage to get Schwab to lower my rates.

Things I’ve learned in this trade:
1) Only be willing to sell call options at a price that I will actually be okay with giving up the stock at. When I sold the initial call at a strike of 37.5, KMI was at 35.75, giving me a 4.9% upside protection for my call expiring in two months. As the Kinder-Morgan mergers were announced, the stock price shot up to almost 42. As mentioned above, my cost basis was only 39.19. While I could have just waited and been okay (knowing what the stock price is now at option expiration), I had decided to roll it because I didn’t want to miss out on any movement above 40 and thought that the company was poised to do even better now after the merger. In the future I’ll only sell call options if I want to get out of the stock or at a price above my cost basis.

2) Wait until near option expiry before rolling an option in duration or rolling it higher. I sold the original option on 7/2/2014. Two months prior to expiration I rolled it up because it was already just above my strike price. I should have waited because if I would have rolled it closer to expiration there would have been less extrinsic time value factored into the cost and I could have gotten a better price.

3) With high commission cost, it is best to let the trade run out as long as possible. Commissions (at least at what I’m paying now) greatly eat into any profit and magnify any loss. On this KMI trade, for example, I loss only $9 on the actual trade. However, commissions added an additional $20.18 to the loss!

9/20/14 option expired
Profit/Loss: -$29.18
Please see Scott’s Options to see all my current and past option trades.

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2 Responses

  1. I’m guessing you didn’t like the recent announcement about the KM companies. That’s why I only write covered calls against companies that I’m looking to exit or reduce the position. When I make a purchase I’m in it for the long haul, barring gross overvaluation or changes with the company or growth prospects. Will you be looking to close this out or ride it out and hope it closes under $40 at expiration.
    JC @ recently posted…Weekly Loyal3 PurchasesMy Profile

    • scott says:

      Hi JC,

      Let’s just say that if I knew about the recent announcement I wouldn’t have sold the covered call. Since I’m already down a bit since I bought the 37.5 back, I’ll just ride it out. If it finishes not too far above 40 I’ll get it taken away for a small capital gain. I do like KMI and will probably buy them back on any small correction.

      I agree that covered calls are best when wanting to exit or reduce position. However, I thought I was safe reducing cost basis as well with the low volatility and the fact that it hadn’t traded at 40 for over two years.

      As far as a learning experience, this one at least didn’t cost me that much.

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