It's rare when the owner of an option contract chooses to execute assignment before a contract expiration date. This scenario just happened to me. I sell options to collect premiums, that's it. I do only sell calls and puts on stocks I either want to own or don't mind losing, but the goal is for contracts to expire worthless. An option that expires without a transaction is awesome, because I just collect premiums and keep my shares.
I learned a good lesson this week, one that I want to share with all of you. The lesson is be prepared for early contract execution. It's an edge case, but it happens. When, it does happen, option ROI can get muddled as in my case. I gave up 100 shares of AT&T (NYSE:T) and missed out on a dividend payment.
The Option Details
I sold a covered call against my AT&T shares. The contract was 100 shares at $41.00, expiring on 7/29/16. Cost on the transaction was $0.49, which paid me a premium of $39.29 after trading fees. I sold this short timeframe, near the money call because of AT&T's recent price surge. I thought the stock had temporarily topped out and this seemed like an easy money play.
Honestly, I thought the stock would drop back under $40. However, if the contract were called, I was fine selling my 100 shares at $41, plus $39.29 in premiums. I'd also collect $48 in dividend income. My cost basis on AT&T shares is $30.76. With this transaction, 100 at $41 shares plus premiums and dividends totals $4,187.29. Less $3,076, my income for the transaction would come to $1,111.29.
This was the scenario I calculated before selling the option. However, since the contract was assigned prematurely, I missed out on dividend income.
The rub here is that I sold a contract that expired a few weeks after AT&T's dividend ex-date, which was July 6th. 100 shares of AT&T stock, would've paid me $48 in dividends on August 1st. This dividend income would've been paid to me whether the options contract was assigned or expired worthless.
Because the contract was called early, I'm losing out on $48. Essentially, I sold a contract that made me $39.29, but lost out on $48 in dividends. Ouch this stings! The owner of the contract chose to close the contract on AT&T's ex-date, which allowed him or her to steal my dividend.
I lost my dividend income and I gave up 100 shares of AT&T. I did still make $1,063.29 on the transaction, but it still stings. It stings because I would've most likely bought to option back to close at a discount, then sold another option at a higher strike price, expiring at a later date; essentially keeping my shares.
The takeaway here is that people can and do take contract assignments early. It's not the end of the world, but it can happen. I wanted to share this with all of you because I know many of us DG investors are exploring options as a secondary revenue source. I factor dividend pay dates and dividend income into my option contract calculations. I'll continue to do this, but from now on when calculating downside, I'll factor in the what-if scenario of an early contract closure.
Every cloud has a silver lining. I immediately put my capital back to work and sold a new cash secured put for Magna (NYSE:MGA). The transaction details: $32.50 expiring on 8/28/16. At a cost of $1.19 per share, I was paid a premium of $109.29 after fees. So looking back maybe it's a good thing that my AT&T contract was called early. I missed out on $48 in dividend income, but traded it for $109.29 in options income. Plus, MGA is a stock I really want to buy more of. If the contract is assigned, I'll happily take the 100 shares at $32.50.
Disclosure: Long T and MGA.