On June 27, 2017, we published a Tear Sheet highlighting a bond replacement investment in IBM. The investment we detailed was a covered call struck at $155.00 / share to receive a premium of $5.05 / share, implying an effective buy price of ($155.00 – $5.05 =) 149.95 / share.
A few weeks later, IBM’s share price dropped heavily after the firm reported second quarter earnings. We published another Tear Sheet highlighting a bond replacement investment structured as a short put with a strike price of $145.00 / share to receive a premium of $4.65 / share, implying an EBP of $140.35. (The implied volatility was higher in July, but there was less time value, generating a smaller cash inflow).
Both options expired last Friday (October 20, 2017), and the stock price was higher than both strike prices after the firm surprised the market with strong third quarter earnings and soared by around 10%. Because the options expired Out-of-the-Money, investors were able to realize the full premium on both options, generating period returns of 5% and 3% respectively (15% and 14% annualized).
As we point out in our video explanation of bond replacement investments, quarterly earnings season often offer excellent opportunities for bond replacement investments, and IBM has been a case in point over the last several years. Each of these investments essentially generated more than two times the cash inflow over a period of a few months that IBM bonds maturing in October 2018 were paying when we initiated the investment (presently yielding 1.7%).
We will update our IBM model after analyzing the information from the earnings announcement and will publish an update subsequent to that.