Yesterday, we executed the Abbott Laboratories (ABT) October 44 Buy-Write following recent bullish option order flow and Chief Analyst of Cabot Benjamin Graham Value Investor Roy Ward’s price analysis.
As I said in my alert, by no means am I calling a bottom in the market, or in ABT stock. However, the time felt right to execute a new bullish trade into the current market selloff.
I often get asked, “How do you choose which call to sell when executing a Buy-Write?” Because of the market’s weakness recently, I’ve been trending more and more defensive. And that’s why I chose to sell an October at-the-money call.
Had I decided to sell the September 44 Call, the premium we would have received would have been $1.45—$0.76 less than the premium from the October 44 Call.
Had I decided to sell the October 45 Call, the premium we would have received would have been $1.55—$0.66 less than the premium from the October 44 Call.
As you can see from the examples above, by selling an at-the-money call with over a month until the call’s expiration, I’m building in a bit more “cushion” if the market, or ABT, were to continue to fall. This trade is about creating yield, not hitting a home run.
Another question I often get is about volatility. When I write about volatility in options, I’m referring to the price of options. Because of the recent call buying in ABT and market volatility, ABT volatility/price of options, were off-the-charts expensive. Here’s a graph of the extreme price of ABT options:
As the chart above shows, current option volatility is approximately double the typical price of ABT options.
So what does this high volatility mean in terms of the price of options? If ABT volatility were trading at normal levels, this option that we sold for $2.21 would be trading for approximately $1.10. As you can see, we sold an option that was theoretically overpriced by $1.11. This is a staggering premium in comparison to typical pricing of ABT options, and why I chose to execute a buy-write, which is a volatility selling strategy, instead of paying for an overpriced call.
As I mentioned in the trade alert, we may also receive the $0.24 dividend in early October. If ABT explodes higher before the dividend date, we will likely not get paid the dividend, but will have made our 5% on the Buy-Write. If ABT chops around or goes lower, we will likely receive this $0.24 payment per 100 shares owned. I will update the likelihood of this scenario as we get closer to the October dividend date.
If the trade goes bad, I will lean on Roy and his analysis to help guide us. Roy is a long-term holder of stocks and his trading record is outstanding. However, Roy is a buy and hold investor, but if this trade goes bad, I may “scalp” the options or adjust to continue to lower our cost basis.
As I’ve said, picking a bottom in this market is impossible. The market could be up or down 3% every day this week. While this trade is a defensive long, a 5% yield in just over a month is a home run these days. That said, if the market strengthens in the coming days/weeks, I’ll push call buying more aggressively in recently beaten down technology and biotech stocks. However, in light of yesterday’s 3% selloff, defensive trading seems to be the right strategy for this environment.