High Quality Investment Problems Require Nuanced Answers

Some investment problems are well worth dealing with. On March 30, 2020, I noticed that shares of LPL Financial were available for south of $52. They were down from nearly $100 just prior to the Covid-crisis. My calculated normalized price-to-earnings for LPLA at that time was 19.3-times. Its typical yield was about 1.94%. Picking up shares at 7-times projected earnings per share seemed like a no brainer. Here's my graphic from an article published here at that moment. By October of 2020 the stock had advanced about 50% yet still appeared undervalued. LPLA was a true left-to-right growth vehicle at a decidedly pedestrian valuation. My end of 2021 target price stood at $121.60, about 61% plus dividends above its Oct. 29, 2020 quote. I recommended LPLA in June of 2021 with the stock at $137.25 and its price-to-earnings was still slightly below normal. In 2022 year-to-date, LPLA has changed hands as high as $196.29, exceeding my goal price. As such, I've already disposed of the bulk of my old position for sensational gains. I still hold 600 shares in my TradeStation account which were bought higher and later than my March of 2020 purchases. The 500-share lot has a cost basis of $87.97 per share. The last 100-shares were added at $123.48. LPLA is a fine company with good long-term prospects. That said, the stock is no longer bargain-priced at 22.5-times its 2022 estimate. The current yield is now a well below average 0.54% as well. Why do I still have these 600 shares then? I sold covered calls on them a while back at $170 and $175 strike prices. The $170 calls brought in $7.23 /share. The $175 strike price call was sold later, at $14.50/share. Naked puts I sold when LPLA was much lower have all expired worthless already (the best-case scenario for any option seller). I'm still short two contracts of LPLA's July 15, 2022 expiration day $160 puts, which were written with LPLA at about $168. With LPLA now at $187.30, I'm willing to simply let everything ride as is for the moment. If the stock holds at $160 or better, as I expect, the two puts, sold for $16.40 per share, will expire on July 15 for a $3,280 net gain. What about the covered calls? If LPLA continues to hold above the strike prices and I take no further action all 600 shares will be called away. The graphic below is a hypothetical look at what will unfold on expiration day if LPLA merely holds at $175 or higher. I suppose it could reach $200 by then, though. If simply left alone, the most likely results will be as shown below. I'd book $54,847 in long-term gains and have plenty of cash to reinvest. Note: Option premiums from covered calls on stock held over one year in taxable accounts become part of the sales proceeds. That turns the option premium into long-term gains, if exercised. The called-away prices shown above equal the strike prices plus the original call premiums collected per share. Here is the finesse move I wrote about earlier. Letting the shares get called away generated a $54,847 long-term gain. There is nothing to prevent you from buying back the now money-losing calls on or near expiration day, though, while selling the shares you own separately. The table below shows the net results tax wise if that was accomplished while paying 25 cents per share above intrinsic value to close out with just hours to go. As long as the shares were held more than one year you'd now have a much larger long-term gain of $63,667 plus a short-term loss of $8,970 to offset income at your higher marginal tax rate. The $150 smaller final net gain would be worth much more on an after-tax basis than simply letting your shares get called away. The higher the stock is on expiration day the more valuable this technique becomes versus not unwinding the call options. What are the key takeaways from all this? Don't be afraid to average up, or down on shares you love. Stocks can still be bought on the way up as long as they remain undervalued. Selling covered calls reduces risk by the amount of the premium taken in. Unwinding option positions near expiration dates can provide meaningful tax benefits. Writing naked puts can often add significant profits to you bottom line.

High Quality Investment Problems Require Nuanced Answers

Let's look at what happened to my position in LPL Financial and how I'm handling it.

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