Let me get one thing out of the way before launching into the heart of today’s commentary about yesterday’s unusual options activity.
I believe that Warner Bros. Discovery (WBD) CEO David Zaslav is not only one of the most overpaid CEOs in America, he’s also one of the most overrated. There, I said it.
In Wednesday trading, the WBD June 28 $8 call had a Vol/OI ratio of 476.70 -- I excluded any options contracts expiring tomorrow from consideration -- that was the highest call or put Vol/OI ratio on the day with a volume of 106,305, 1.4x the 30-day average for all the WBD call and put options available.
As I said, I’m no fan of the CEO and the value destruction he’s delivered to long-time shareholders. If you own WBD stock, this call seems ideal for generating potential income from your existing ownership.
Here are the pros and cons of such a move.
Selling the Call for Income
Investors sell call options to generate income from their long stock positions.
Covered calls have become so popular that at least three ETFs with net assets over $1 billion, including the wildly popular Global X NASDAQ 100 Covered Call ETF (QYLD) with $8.21 billion. While WBD is one of the holdings at 0.14% of the ETF’s net assets, it’s not even in the top 25.
When you own 100 shares of WBD, you can sell one call option and receive the option premium for doing so. Should the share price be higher than the strike at expiration, the buyer of the call has the right, but not the obligation, to exercise that right to buy the shares at the contract’s strike price.
So, let’s say you own 100 shares of WBD that you bought in July 2022 at $15. That $1,500 investment was worth $789, as I wrote early on Thursday's trading. The bid price at yesterday’s close was $0.44, providing an annualized yield of 56% on yesterday’s closing price of $8.06, six cents in the money.
Suppose you can repeat that nine more times over the next year; you’ve created a very attractive passive income stream. If, if, if!
The Downside of Selling the WBD Call for Income
Because you purchased the 100 shares at $15, you’re currently sitting on an unrealized loss of $7. As long as you don’t sell the shares and crystalize your loss -- I assume you would have done so by now -- this bullish stance suggests you’re willing to wait for Zaslav’s so-called genius to emerge. And that’s more than satisfactory.
However, if the share price moves up to $8.5o in the next 36 days, the buyer is likely to exercise their right to purchase them at $8, and you would have your 100 shares “called away” by the buyer, effectively crystallizing your loss, less the $44 in premium.
To avoid selling the stock, you could buy back the covered call to close out the obligation to sell the stock. You then could sell another call at $9, which is 50 cents out of the money, ultimately trying to avoid selling your stock while generating income.
At the same time, if the share price falls to $7.50 instead of $8.50, you’ve got another problem: your 100 shares held long have lost more value than the premium received.
It gets more complicated from there. Maybe I’ll delve into this more in the future. Suffice it to say that covered call options possess risks you ought to be comfortable with before trying to generate income from them.
Selling Puts Might Make Sense
For the investor who’s lost approximately 50% of their investment, selling puts rather than calls might make sense. You want the share price higher than the strike or out of the money to get the premium while avoiding buying more shares.
In yesterday’s unusual options activity, the June 28 $7.50 put had a closing bid price of $0.18, an annualized yield of 22% over the same 36 days. Based on the $8.06 closing price, the shares would have to drop to $7.32 before you’re losing money.
In the worst-case scenario, you have to buy 100 more shares at $7.32. That effectively lowers your average price paid to $11.16, reducing your unrealized loss to 34% from 50%.
Now, I’ll be honest. I don’t have much confidence in WBD’s share price moving much higher than $10 in the next year. There are still too many question marks regarding future revenue and earnings potential to warrant serious consideration as a long-term buy for anyone but the most risk-tolerant investors.
It is definitely not a buy-and-hold proposition, in my view. That makes WBD covered calls a risk not worth taking.
However, the person or company that made two trades for 105,000 June 28 $8 calls at 10:32 a.m. on Wednesday felt otherwise.
Govern yourself accordingly.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
