Cummins Inc. (NYSE:CMI), a subject of many posts on this income investing blog, is the subject here again.
CMI belongs to the 2016 Dividend Portfolio. We have a Dec. $130 call working. Today, CMI traded as high as $138.77 but closed at $134.74. With our $130 call working, I would not be surprised if we lost CMI. But the call buyer has not yet executed the option although they are in the money.
What will happen?
Our basis is $118.50. We banked a call premium of $1.75. Lucky for us (or is it good planning) CMI is ex-dividend on 11/17/2016 so they have to take our shares before 11/17 or we get the dividend of $1.025.
With the controversial news (see link) perhaps the call buyer will not execute the option out of fear that the price will fall further. Here are our options:
Should the owner of this call execute the right to buy our shares before the ex-dividend date 11/17, our gain is
Should the call buyer execute their option after the ex-dividend date 11/17 at $130 our gain is
We have only two outcomes. We own the stock at the end of the expiration date or we do not. If we still own it, we know what we have but if we lost it what is our loss?
Lost opportunity means we are losing out on potential future price appreciation. The option buyer is already in the money. Some will argue that CMI is on a roll and will continue to be on a roll. They argue this dip is an opportunity to buy. Selling a call on your shares at $130 was silly. Even on the dip, CMI is $134. You would be better off to hold the share through thick and thin. I argue that we all can win.
We still have until December 16. We cannot sell our shares before then as we are under contract. Maybe the stock price continues to decline. We are under contract, we have to keep it until the call expires which means the stock price could go to zero. That is a silly thought.
How likely is it that CMI will drop below our basis of $118.50 is a serious thought. I think that scenario is highly unlikely but it is possible. On the other hand, CMI could rebound and be well above $130, when the call expires the call buyer takes our shares but we all win. Just look at the tables above.
If CMI is $129 when the call expires, we will mostly likely retain our shares and have another chance to sell another call at a wonderful premium. Select your call wisely and you will get the dividend too.
I am looking to add to CMI and sell a call. Today I could add CMI at $134 and sell a January $145 for $1.45. If I buy before 11/17, I will get that dividend as well.
I even looked at a March Call. We would get two dividends plus the call premium.
But you must realize the risk of being in contract and unable to sell if your stock dives. You must understand if you buy such a good stock that you can get increasing strike prices and increasing call premiums that you will lose it to the call buyer; lost opportunity.
I like these options.
Disclosure: Long CMI with calls