This week’s High-Yield Trade of the Week is with Discover Financial Services (DFS).
I just made a similar trade in my retirement portfolio this morning. In short, I sold another call option on the 100 shares of DFS I had purchased in a previous high-yield trade. The original call option generated $443 in cash and expired on January 18, so I’m still holding the shares. Today, with DFS shares trading above my purchase price of $69.93, it seems like a great time to sell another call option and generate additional income.
If you followed along with my original trade, consider selling another round of call options here. I just sold the January 17, 2020 $72.50 option for $5.30 (which generated $530 in cash).
If you’re not already in our previous DFS trade, and you’re looking for a new high-yield trade idea with the stock, here’s the opportunity we’re looking at as we go to press…
High-Yield Trade of the Week:
Sell the October 18, 2019 $72.50 call on shares of Discover Financial Services (DFS)
As we go to press, DFS is selling for around $70.90 per share and the October 18, 2019 $72.50 calls are going for about $4.40 per share.
Our trade would involve buying 100 shares of DFS and simultaneously selling one of those calls.
By selling a call option, we’re giving the buyer of the option the right, but not the obligation, to purchase our 100 shares at $72.50 per share (the “strike” price) anytime before October 18 (the contract “expiration” date).
Because we’re collecting immediate income when we open the trade, we’re lowering our cost basis on the shares we’re buying from $70.90 to $66.50.
In other words, we’re buying the stock at a 6.2% discount to its current price.
That’s what makes this trade safer than simply purchasing shares of the underlying stock the “traditional” way.
With all of this in mind, there are two likely ways our High-Yield Trade of the Week would work out, and they both offer significantly higher income than what we’d collect if we relied on the stock’s dividends alone.
To be conservative, we don’t include any dividends in our calculations for either of the following scenarios. The annualized yields are generated from options premium and applicable capital gains alone. So any dividends collected are just “bonus” that will boost our overall annualized yields even further. Let’s take a closer look at each scenario…
Scenario #1: DFS stays under $72.50 by October 18
If DFS stays under $72.50 by October 18, our options contract will expire and we’ll get to keep our 100 shares.
In the process, we’ll receive $440 in income ($4.40 x 100 shares).
That income would be collected instantly, when the trade opens.
Excluding commissions, if “Scenario 1″ plays out, we’d receive a 6.2% yield for selling the covered call ($4.40 / $70.90) in 221 days. That works out to a 10.3% annualized yield.
Scenario #2: DFS climbs over $72.50 October 18
If DFS climbs over $72.50 by October 18, our 100 shares will get sold (“called away”) at $72.50 per share.
In “Scenario 2” — like “Scenario 1” — we’ll collect an instant $440 in income ($4.40 x 100 shares) when the trade opens. We’ll then collect another $160 in capital gains ($1.60 x 100) when the trade closes because we’ll be buying 100 shares at $70.90 and selling them at $72.50.
In this scenario, excluding any commissions, we’d be looking at a $600 profit.
From a percentage standpoint, this scenario would deliver an instant 6.2% yield for selling the covered call ($4.40 / $70.90) and a 2.3% return from capital gains ($1.60 / $70.90).
At the end of the day, we’d be looking at a 8.5% total return in 221 days, which works out to a 14.0% annualized yield from DFS.
Here’s how we’d make the trade…
We’d place a “Buy-Write” options order with a Net Debit price of as close to $66.50 ($70/90 – $4.40) as we can get — the lower the better. Options contracts work in 100-share blocks, so we’d have to buy at least 100 shares of Discover Financial Services (DFS) for this trade. For every 100 shares we’d buy, we’d “Sell to Open” one options contract using a limit order. Accounting for the $440 in premium we’d collect for selling one contract, that would require a minimum investment of $6,650.
P.S. We’d only make this trade if: 1) we wanted to own the underlying stock anyways 2) we believed it was trading at a reasonable price 3) we were comfortable owning it for the long-haul in case the price drops significantly below our cost basis by expiration and 4) we were comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of our total portfolio value. In addition, to minimize taxes and tax paperwork, we would most likely make this trade in a retirement account, such as an IRA or 401(k).
Please note: We’re not registered financial advisors and these aren’t specific recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we do our research, to the time we publish our article, to the time you’re alerted about it. So please don’t attempt to make this trade yourself without first doing your own due diligence and research.