On May 2, 2014 (the spot labeled “A” in the diagram above), we sold calls struck at $41 and expiring on July 19, 2014 on the remaining 100 shares of Oracle in the IOI Model Portfolio. In return, we received about $150 ($1.51 / share before fees) in premium.
By selling the covered call we effectively agreed to sell the shares at $42.51 ($41 strike price + $1.51 in premium). (Read our article on Covered Calls to better understand these oft-misused option strategies)
For those who like to think of sold option premium as being similar to a dividend payment, we generated about twelve and a half quarters worth of Oracle’s $0.12 / share dividend simply by agreeing to part with our precious ownership stake in Oracle if requested over a period of about two and a half months.
This strategy seemed sensible at the time, as you can read in my post about the transaction.
However, just as I was complementing myself on my investment acumen, Oracle’s price soared from the $41 mark to the $42+ range (the area labeled “B” in the diagram above). It was at this point that I began to doubt the decision to sell the covered calls and began remembering the advice I always give to others about this instrument: don’t sell them on stocks you want to keep owning.
By the spot marked by label “C” above (when the stock was trading above my effective sell price [ESP]), I was thoroughly disappointed in myself for my lack of foresight. The company released quarterly earnings and the shares dropped heavily (the spot labeled “D” in the diagram above). Again, all was right in the world–in my mind, I was back to being an insightful, skillful investor again.
The chances are pretty good that our sold call options will expire worthless this Friday, so I don’t mind titling this post “Whew!”
Last Friday’s price closed at $40.13, about 2% under our calls’ strike price, so unless Oracle can string together a few successive good trading days this week, we’ll either still own the stock or will have realized nearly all of our premium income when the option expires.
Looking back, though, there are a few things I learned from this investment:
- Charlie Munger opined recently that he and Buffett tend to make better decisions when they tune out distractions and make fewer decisions (this linked WSJ article is a good one, by the way). By transacting in the covered calls, I forced myself to make an additional decision–what to do if the stock was called from me. Thinking back on it, I would rather not make this extra decision and it was wrong for me to force myself into the position to have to do so.
- My original valuation of Oracle was done just about one year ago and I have not refreshed that valuation. Presumably, the corporation will have become more valuable over that time, but before making the transaction, I did not factor in the added value. This was probably a mistake.
- I really do like Oracle and I would not mind keeping some position in it for a long time. By selling covered calls on it, I broke my own rule about not selling covered calls on stocks you want to keep holding. This was certainly a mistake.