Did Ford have an earnings report or what? I ended Trading on Margin Challenge – Episode 1 teasing the coming earnings report for Ford. If the earnings were a Chevy, they’d be a Nova. If they were a Ford, they’d be a Pinto. Do I hear a Daewoo? Don’t shout me down when I’m preaching good!
Now that I got that out of my system, let’s get into the challenge. Ford reported earnings February 4th during after-hours trading. It wasn’t pretty. They lowered 2020 guidance and missed fourth quarter estimates. The ticker had rallied all day long hitting a high of $9.24. Things were looking rosy. When the earnings report dropped after the market closed, so did the price. Dropped right through the $8.50 support level and down into the $8.20 range. This could have been a serious gut punch to my trading on margin challenge.
Covered Call to the Rescue
Let’s rewind back to Monday, the 3rd of February. I had the day off and had time to watch Ford during market hours. The price toyed with $9.00, but it didn’t want to stay over that mark. I knew the earnings report was the next day, and I wanted to hedge my play and reduce risk going into earnings, an event that is a catalyst for big moves.
Part of my strategy, in this challenge, involved holding one hundred shares of a company so I could sell a covered call if needed. This gives me another avenue for generating income especially if I believe the stock price will remain stable or run lower. On Monday morning, buyers of calls were willing to pay a premium of $0.23 a share for a $9.00 strike price. This meant I would earn $23.00 for selling the call.
I jumped at the opportunity. If the price skyrocketed after the earnings report, I would essentially be selling my one hundred shares for $9.23 a share even if the shares were worth more than $9.23. Not ideal, but still okay since I bought my shares at $8.98. In this scenario, I come out ahead $25.00. If the price stayed below $9.00 by the expiration date, the contract expires as worthless. I keep my one hundred shares and the $23.00 premium. Selling this call allows me to earn income even if F dives well below the $8.98 I paid per share. I can then wait for the share price to recover and climb back above $8.98. Or I can turn around and sell another call. At the end of this post, I’ll provide more detail on selling covered calls for anyone interested in my rough and tumble explanation.
Margin Challenge Status – February 5th, 2020
100 shares of F at $8.98 per share for total of $898.11 on margin.
- Minus $10.25 in interest. Accruing at $0.125 a day. (82 days in)
- Plus $15.00 from Q1 2020 dividend.
- Plus $35.00 from premiums for selling 5 covered calls since the start of the challenge.
$36.12 ahead in the challenge on March 6, 2020.
Currently $39.75 ahead in the challenge.
I am pleased with how the margin challenge is going so far. It is far from ideal since F sits at $8.32 at the time I’m writing this. However, I have built up a good cushion by getting into F in time to earn the Q4 2019 dividend and by selling a call.
Super Exciting Section on Covered Calls
A stock option is a contract that represents one hundred shares of a stock. Selling a covered call means that I am agreeing to a contract to sell another party one hundred shares of a stock at a set price, the strike price, by a set date. The other party pays me a premium, like a down payment, for the right to buy my shares at the strike price.
If the stock price has risen above the strike price before or on the expiration date, the buyer exercises the contract and buys my one hundred shares at the strike price. I keep the premium and sell my shares at the strike price. In this scenario, I could be leaving money on the table if the stock rallies hard and is sitting well above the strike price.
If the stock prices stays below the strike price, I keep the premium and all the shares and the contact expires. This is my crude explanation for selling a covered call. I learn best with real world examples, so I’ll walk through my actual covered call with Ford (F).
Ford Covered Call
On February 3rd, I agreed to sell one hundred shares of F at a $9.00 a share strike price. The contract I agreed to sell has an expiration of February 7th. I was amenable to this contract since my cost basis for my shares was $8.98 and because buyers were willing to pay a premium of $0.23 a share. I pocket $23.00 ($0.23 x 100) as soon as someone buys my contract. If F rallied and rose above $9.00 a share, the buyer exercises the right to buy and will then purchase all one hundred shares at the strike price of $9.00. I will have left money on the table if F rallied above $9.23, but I still make a profit given my $8.98 entry point.
If F drops and stays below $9.00, I will keep my shares and the $23.00 in premium income. Generating income is especially important here as these are shares I own on margin. I want to keep ahead of the interest I am being charged while I wait for the best opportunity to sell and close out the position.
Thank you for reading my clunky explanation of a covered call. Feel free to google “options trading” to find formats that work best for your learning style. Joe provides good starting info on options trading in his post My Trading Strategy.