Tomorrow is expiration Friday, will my Realty Income (O) covered call expire worthless or not?

I have a few option trades expiring tomorrow and they are all in good standing and most likely expire worthless.

I also have Realty Income covered call trade open set to either expire worthless or execute. What will happen? I do not know. I do not know whether the contract expires worthless or will be executed. If I knew I would be predicting the future. Unfortunately I do not know how to predict the future.

I only can react to what is happening and what will happen tomorrow.

When I was opening this trade last month, see details of this covered call here, I knew the trade was very tight.

I was very close to the strike price and the stock’s fall was slowing down making it a bottom or consolidation. The chance that the stock will break up above the strike price of $40 a share was quite high.

Realty Income Chart

For the whole month the stock was attacking this level, but mostly stayed below. Except yesterday when the market was pushed up by tapering halt by FED. The stock shot well above the strike.

Although it is now correcting back down, it is not certain that the stock falls down below 40 dollars and the execution is very likely.

If you follow my blog, you know that I sell covered calls against stocks which I do not mind being called away. Well, Realty Income is not that stock.

Realty Income is one of my precious stocks, usually called as core portfolio. I was buying this stock for dividend income. And it looks like that tomorrow I will be forced to sell 100 shares of my Realty Income stack.

What can I do to deal with this situation?

It is a very important part of investing or trading. You have to have a plan for every possible situation to be able to repair or deal with the trade.

Based on the current price action I have the following options to do:
 

  1. Roll the covered call away in time.
  2. Roll the covered call away and up
  3. Let the covered call be exercised

 

Roll the covered call away in time

This strategy is easy and it is exactly what it says. I would buy the September covered call back and sell the same strike covered call with expiration in October.

With this step I would buy the stock more time. But the strike price would stay the same – 40 dollars. Will the stock stays bellow 40 dollars in October? Maybe. But I do not know it and when looking at the chart I am not convinced about the direction. I do not see any substantial pressure neither up or down.

With this outlook I am not much confident extending this trade, although it most likely will be a credit trade and I will make more money. But the risk if too big for me.

The stock may continue up and by October it may end up at 45 dollars a share and in that situation it will be a lot worse fixing the trade. So I am not in favor of this approach.

Roll the covered call away and up

This fix would mean that I would buy the existing September 40 strike call back and sell a new 45 strike in May 2014 expiration call. I will move my strike higher and further in time. The problem with this trade is, that although I buy more time and room for the stock to go, it will be a debit trade. I will pay for this trade almost everything the original trade has made. And yet I will extend my uncertainty. So what’s the point? I do not see too many benefits yet.

Thus this trade is also unlikely for me to take to fix this trade.

Let the covered call be exercised

Surprisingly this is an option I currently favor to take. If you just read above that I do not like my stock to be called away, you may be asking why I am OK to let this trade be exercised?

Here is my point of view.

When exercising a covered call option like this one I have, you can chose which shares you deliver to the buyer on the other side of the contract. If you take a look at My Trades & Income chart you can see that I bought some of my Realty Income shares for $50.24 a share! today it looks crazy, but back then it looked like a great opportunity.

I can take those shares and sell them to the buyer for 40 dollars a share. Sure I will take a loss, but this gives me an opportunity to buy my shares back on the following Monday for a lot cheaper price!

Here is my expectation:

I will sell 100 shares which I bought for $45 – $50 a share and sell them for 40 a share tomorrow.

I will immediately buy 100 shares of Realty Income on Monday for $40.50 – $41 a share and replace my original shares.

Although this is mostly administrative procedure, it will significantly improve my cost basis of my overall holdings. I will take a loss which I apply against taxes (which is already accounted for in my account value anyway), lose very little on transaction fees, and end up with the same amount of shares for lower cost.

I wouldn’t be able to do this step if the covered call was too ITM, but being ATM will not cost me almost anything and improve my overall holdings.

 





9 responses to “Tomorrow is expiration Friday, will my Realty Income (O) covered call expire worthless or not?”

  1. Bret says:

    Obviously I’m replying to an older article at this point, but this “administrative” plan of having a lot called away (“sold”) at $40 and then buying another I’m pretty sure runs into the “wash sale” rule, which is a giant pain. It basically invalidates your tax loss. I’m not 100% sure if it would affect this case – I do know it was created to prevent people from doing things like sell at a loss in 2013 and buy again in 2014 to delay taxes, but I seem to recall it affecting the rest of the year as well. You might want to look it up and reply or post an article on WHAT IF you did have the shares called away and then bought new ones (with respect to the Wash Sale Rule).

    I also try to tend to avoid having too much attachment to one stock. I do like O, but only at a certain price. If I sell a covered call on it, then it is because I probably wouldn’t mind selling shares at that price. It has been my experience so far that the covered calls on O aren’t worth the risk, so I’ve never sold any, but I do love selling short puts on it and either getting the shares cheap or making $ while waiting.

    • Martin says:

      Well, this option expired worthless so I didn’t have to deal with repurchasing the stock. I trade covered calls against O very sparingly just because of what you have just said and only when I am sure that the odds are on my side. Although not always 100% sure, but as much as possible. All is about evaluating the risk and willingness to take it, right? At this point trading covered calls against O doesn’t make sense from my point of view. The premium is small and the stock is set for the upwards run, so I switched into selling puts.

      As far as the wash sale, yes it will be a wash, but I do not see any big impact on my side since I will be selling higher priced lot and buying a cheaper lot so my cost basis gets lower although it is only an administrative switch. What is the tax implication on that I bet my accountant will find a way what to do. But overall, I am not trading this stock and try not to.

      Thanks for stopping by and posting your input on this!

      • Bret says:

        To anyone interested –

        I found the wash sale info:
        http://www.investopedia.com/terms/w/washsalerule….

        …prohibits a taxpayer from claiming a loss on the sale or trade of a security… The rule … when an individual sells or trades a security at a loss, and within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so.

  2. Martin says:

    Hi Dividend Swan, well, I had a plan for that case and tried to describe what would happen or what I would do if that situation happens. Fortunately I didn\’t have to deal with it, since the call expired worthless. But it was close. With the stock price that low or close to strike I could buy my shares back for maybe even cheaper, because on Monday I expect the market going lower as well as this stock. Thanks for stopping by.

  3. I once sold a covered call against my Realty Income shares. I had to take a loss to offset and close my position out as I did not want to take the risk of losing the shares of one of my favorite companies.

    The only other covered call I sold against my shares worked out for the better as it was an MREIT that after getting the shares called away continued to decline and repeatedly cut their dividend.

  4. I once sold a covered call against my Realty Income shares. I had to take a loss to offset and close my position out as I did not want to take the risk of losing the shares of one of my favorite companies.

    The only other covered call I sold against my shares worked out for the better as it was an MREIT that after getting the shares called away continued to decline and repeatedly cut their dividend.

  5. I sold a covered call against O one time and before the expiration took a loss to buy back the option because I did not want to risk losing the shares of one of my favorite companies. The only other one I used a covered call against was a risky MReit and I’m glad most of the shares are gone as they continually have been declining since and cut the dividend several times.

  6. CI says:

    O seems to have been very volatile the past few months and could swing wildly either way. Based on the current price it appears you’re going to be -100 O shares, but we don’t know for sure.

    If this stock is held in a taxable account I would consider letting it be called away to claim a loss against your 2013 taxes (choose the highest cost basis). It can always be bought back. Or it might even expire worthless and therefore save you a couple commissions. If it were me, I’d probably cross my fingers and let it ride. You can win the battle, but perhaps not the war, either way.

    If it is held in a retirement account, I have no opinion.

    Best Wishes!

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