On November 6, 2009, I purchased a block of shares in Caterpillar (NYSE: CAT) for $57.83 per share. Simultaneously, I sold the equivalent number of call options with a strike price of $65 and an expiration date of January 21, 2011. The price I received for each call was $6.89. As the option I was selling was out of the money to the tune of over $7, I thought this to be a nice price to receive. So, I basically paid out-of-pocket $50.94 per share for Caterpillar stock selling for nearly $58/share.
Now, those familiar with call options know I was capping my maximum upside. And with this trade, I had room for the the stock to decline by 12% before I realized any loss. Based on what I had read and what I learned form the research of others, I felt this unlikely.
Caterpillar has vacillated from low to mid 50s up to close to $70 for most of the first three quarters of 2010. In September, sitting at about $65 it began an upward march to the mid 80s. At the end of November I learn my shorted call options were in fact called so I was obligated to sell my shares at the contracted price of $65 even though the market price was $84.69. Sounds like a bum deal for me, huh? Maybe, maybe not.
If I simply bought the shares in November ’09 with out selling the options and sold on November 24, 2010 at $84.69, my return would have been about 46%. NICE!!! – But wait, no investor with common sense goes into a position anticipating that kind of a return. If they do they are not an investor, but rather a speculator. Not my game folks. In my situation I settled for a measly 29.7% return – which is not too shabby. (Dividends helped too.) AND, I gave myself a nice cushion allowing for a 12% decline in share price over the same time period before I would lose one nickel.
I am not a professional investor, nor do I claim to possess any exceptional insight into the equities market. I do however, take a more active role in my investments than many people. For me, this trade was a textbook illustration of how call option writing can produce terrific gains and provide downside insurance.
Thanks for reading. Have a great day!