A Worthwhile Exit Strategy

This week could mark something that hasn’t happened to me in years—I may end up selling my shares of AbbVie (ABBV) at a price below the market value. It’s all going to depend on if the share price ends the week above $280.

Now you might be asking yourself how I got into this position. It’s because I sold a covered call on my shares and now I’m potentially on the hook for a below market price sale this Friday.

If you’re not familiar with options, a call is one of the two basic contracts available in the options market. The other is a put. Both derive their value from an underlying stock and the perceived odds of its share price moving up or down over a set amount of time.

An option contract has both a buyer and a seller just like any other trade. Most discussions about options are looking at the side of the buyer who uses these contracts for insurance on a position or to speculate using less capital. They buy an option contract so they have the “option” to make a move in the future—and they pay a premium for that right.

Extra Income for Me

I prefer to take the other side of the trade as an option seller. Doing so means I will earn an upfront premium—aka extra income for me. In exchange, there’s the possibility I’ll be obligated to take action in the future if the buyer chooses to exercise the option.

Every contract lays out the price that would trigger a potential action and the timeline. Here’s the ticker for the option contract I have right now:

ABBV261016C00280000

And here’s how to read it:

ABBV tells us the underlying stock this contract is based on, in this case it’s AbbVie. Every option contract represents a block of 100 shares. This is important, because you need to have enough cash or 100 shares of the underlying stock in case your option contract is exercised. If you are just starting your investing journey or hold smaller position sizes, this may not be a strategy for you right now. But it can be a strategy to consider as you grow the size of your positions.

261016 is the expiration date shown as yymmdd. Two factors that boost the upfront premium of a contract are time and volatility. Generally, the more time given to the buyer—meaning an expiration date further in the future—the higher the premium collected upfront. I like to use options that expire within 30-90 days and don’t usually sell options with far out expiration dates.

The C indicates you’re looking at a call contract. Calls give the buyer the right, but not the obligation, to buy 100 shares from the option seller until the expiration date. Yes, options contracts can be exercised at any time up to the expiration date, although most of the time they are exercised at market close on that day.

The letter P would indicate a put contract. This gives the buyer the right, but not the obligation, to sell 100 shares to the option seller up to the expiration date.

The final numbers 0028000 tell us this contract has a strike price of $280.

That ticker means I’m currently in a contract with an option buyer where they can “call” or buy 100 shares of ABBV from me for $280 per share until this Friday.

More Than Content with My “Loss”

I rarely use options to speculate. My goal is to select contracts where I’m happy whether the contract is exercised or not. I want to set the stage to profit either way. Plus, as an income investor, I like that upfront premium payment. On this contract I collected $190 or $1.90 per share.

Shares of ABBV closed above $280 on Monday but have since retreated below that price.

If shares end the week above $280, the option buyer will want to buy my shares. He’ll be locking in an entry price below the market price. If they are below $280, I’ll keep my shares and continue to collect my quarterly dividends. And I get to keep my $190 either way.

Here’s where my selection process comes into play. I sold this call as part of my exit strategy. I have a big gain on these shares and I’m worried about a market correction or a major rotation between now and January. I want to lock in some of my profits. Why not collect extra income in the process?

The entry price on my ABBV shares was $154.14. I’ve held them since June 2022 and collected $26.69 in dividends. I will also collect another $1.73 as Thursday is the ex-dividend date. And don’t forget about that $1.90 per share premium.

If I am forced to sell my shares on Friday for $280 that would lock in a total return of 101.3%. I will be more than happy with that and deploy that money on the next up-and-coming dividend stock.

If I get to keep my shares, I’ll look for another covered call to sell, collect another premium, and potentially sell them on the next expiration date. It really feels like a win-win for me.

So, if you have blocks of 100 shares sitting in your portfolio, you might want to think about using covered calls. Just make sure that you’re setting yourself up for success. Make sure your premium compensates you for the volatility and time to expiration that you’re taking on. And make sure that no matter what the outcome is, you’re sitting on a profit.

For more income, now and in the future,

Kelly Green