Early Assignment Risk with Ex-Dividend Date (Real-Life Example With Market Axess)

Introduction

Early assignment with covered call writing is very rare unless there's an ex-dividend date involved. Yesterday, we rolled out our covered calls on Market Axess (MKTX) because of the upcoming ex-dividend date and we didn't want our shares to be called away.


When Does Early Exercise Occur?

If and when this situation takes place, it does not negatively impact our trade setup returns. Early exercise might occur in the following situation:

  • An option is (deep) in-the-money (which is the case)

  • There's an upcoming dividend payment (which is the case)

  • When the time value component of the option (the remaining time value, which can be calculated easily via our calculators) exceeds the dividend amount (which is the case). I'm going to primarily focus on that factor in this article.


Initial Trade (Without the 60 Cent Dividend per Share)

Before we get to the explanation of why early assignment on our MKTX position was likely, let's first take a look at how successful the trade has been so far. We bought the 100 shares at $376 and sold the $440 call for the purposes of portfolio overwriting. The premium return was 2.71% or an annualized 29.32%, perfectly meeting my goal of 30% option return.


(Source: Option Generator's Spreadsheets)


Including upside potential, there's a possibility of generating a one-month return of 19.7%. Our total breakeven stands at $365.80, which will decrease gradually as long as we receive option credits for one-month covered call writing.


(Source: Option Generator's Spreadsheets)


Situation on May 11, 2020 (With the 60 Cent Dividend per Share)

On May 11, 2020 Market Axess was trading at $493.00. The option we sold was worth $53.20. We met our maximum return potential of 19.9% including the 60 cents dividend. Why did we decide to roll out (and up) the covered call before expiration Friday? Because the time value left in the option was $20.00 per contract, less than the $60.00 total dividend per 100 shares that was about to be subtracted from the share price the next day. There was a high chance of getting assigned early, since the option value had already anticipated on the ex-dividend amount.


(Source: Option Generator's Spreadsheets)


Rolling Out and Up: Let's Run the Calculations

We rolled out and up, because we still wanted to hold onto the shares. Market Axess has one of the best spots on our elite long-term leaders watchlist. Why would we allow our shares to be sold? Market Axess sports a 98% EPS rating, meaning its earnings consistency is among the 2% best of the US stock market. Never change a winning team!


Now the question becomes what strike we select for the June cycle.Let's take a look at rolling out (keeping the same strike of $440) and rolling out and up ($470 strike in this case).

We generated an options premium of $63.75 per share for the $440 call, versus $36.65 for the $470 strike. What strike price are we going to opt for? As I remained extremely bullish on MKTX, I decided to select the $470 strike.

(Source: Option Generator's Spreadsheets)


Although the we had to pay a debit of $1,655 for the contract, the return of 3.06% for the June contract is higher because of unlocking bought value in the options closing. Our shares aren't worth $440 anymore; their value has increased to $470.

(Source: Option Generator's Spreadsheets)


What isn't mentioned in the screenshot above is that we also have downside protection of that 3.06% profit as long as the shares do not depreciate from $493 to below the $470 strike. The $440 has more room to the downside, but offers a lower return of 2.40%. Thus, the trade-off between risk and reward should always be considered when executing rolling transactions.


The premium we received consists of $23 in intrinsic value and $13.65 in time value. That $13.65 exceeds the dividend amount of 60 cents, meaning there's a minuscule change of getting assigned on the June options.

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