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Author: jimgillies Big gold star, 5000 posts Top Recommended Fools Feste Award Winner! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 14493  
Subject: Re: Options strategy Date: 9/7/2005 8:15 AM
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Good Morning Brian,

Disclaimer: I've got absolutely no knowledge of Enterprise Products or their prospects. That said, here's my stream of conscienceness thoughts on the strategy. Others may differ with uproarious laughter.


1) A covered call strategy is best viewed as a total position with a stock you don't mind being called away at the strike price. A pure covered call would look at continuous rolling over of the position to improve income from the position.

I've posted this before (maybe on this board - don't remember), but there's an interesting Canadian product available as an exchange-traded fund comprised of the top 15 dividend-paying companies on the TSX. Those underlying companies have an average yield of 3.2%. The ETF is currently paying out 7.4%. It is comprised of nothing more than a portfolio of those 15 stocks - so how are they paying out 7.4%? The answer is that the managers are employing a total-position covered write strategy, taking new positions in stocks that are called away, and rolling over calls that expire worthless. The prospectus is worth glancing through to see their strategy: http://www.dividend15.com


2) The presented return here is not what I would consider especially attractive for a covered call strategy, even if you are proposing the same strategy as the Dividend15 guys (new positions if called away/rolling over worthless options).

Looking at the March 17 expiry, you're looking to receive two dividend payments, the call premium, and the difference between strike and stock price.

Total Return = ($0.42) * 2 + $1.00 + ($25.00 - $24.79) = $2.05

%Return = 2.05/24.79 = 8.27%

Time to Expiry = 174 days = 0.48 years

Annualized = 18.1%

It's not bad, especially, as I said, if this is a continuous strategy and not a one-off. But I'd be really looking hard at what the frictional costs would do to your return. For example, if I'm paying the exhorbitant prices that E*Trade charges me on a single contract, buying and selling the stock (when assigned) as well as the option commission, I drop my period return to 4.9%, and the annualized return to 10.6%. (And I'm not accounting for taxes here - add those if you're not in a sheltered account). So to get the higher target return, I need to minimize commisions by buying more contracts - how many can I afford, is the question.

Compare the above return to analyst's expectations (and I know, that might be rather silly). They're calling for a 1-yr target price of $30.70. So the total annual return if their forecasts are decent, would be [$1.68 + ($30.70 - $24.79)]/24.79 = 30.6%. So it would seem that just buying the stock might be a better choice.

That is, of course, if the dividend is safe. Then again, if the dividend were not stable, it would impact both strategies negatively.

Cheers,

Jim
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