A strategy idea for options trading investors.
Thursday’s Covered Call from MarketTaker.com
Covered calls are popular because they are very simple and have relatively defined risk. The strategy is to buy stock or to have previously owned stock and sell a call against the position to generate additional revenues. The short call position also provides some downside protection for the stock. Generally a trader or investor looks for a stock with a neutral to slightly bullish outlook. Current market conditions have been more bearish than bullish, which has caused many bullish stocks to pullback or remain in a sideways channel.
Herbalife Ltd. (NYSE: HLF) – $54.05
HLF has drifted higher this year. The company’s excellent quarterly results released at the start of May shot the stock up almost $6 in one day. The stock probably won’t do anything that dramatic as investors wait for the next earnings announcement scheduled for August 3.
The market’s decline has kept HLF in a range between $51 and $57 the last two months. The company has exceptionally strong fundamentals and little overhead resistance. Trading volume has increased recently, tightening up the bid/ask spreads on the options and increasing the open interest.
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Covered Call Trade – Buy HLF and sell the July 55 Call
HLF stock has the potential to keep slowly climbing. Selling an at-the-money (ATM) call will give the stock some downside protection in case it continues to chop around sideways. Going forward, an investor long HLF will have the opportunity to continue selling calls against the position. Of course, that will have to be re-evaluated every month. If the stock starts to climb again, then out-of-the-money (OTM) calls can be sold against the position. This particular month, the covered call is more structured for sideways or downside protection than for maximizing returns for a slightly bullish stock.
Trade: Buy 100 shares of HLF @ $54.05 and sell the July 55 Call @ $1.75
Cost of the stock: 100 X $54.05 = $5,405 debit
Premium received: 100 X $1.75 = $175 credit
Maximum profit: $270. That’s $175 from the premium plus the rise in HLF of $95 (55 – 54.05 X 100) if HLF finishes at or above $55 @ expiration.
Breakeven: HLF at $52.30 (54.05 – 1.75) @ expiration.
Maximum loss: $5,230 if HLF goes to $0 @ expiration.
The goal for this covered call is for HLF to finish just at or below $55 at July expiration. The stock is maximized up to the strike price and the call premium is yours because the call has expired worthless.
If the stock starts to rise again, the July 55 call can be bought back and a higher strike can be sold. This can be beneficial especially if the trader or investor does not want the stock being taken away from them.
Dan Passarelli of MarketTaker.com writes the Market Taker Edge options newsletter. Dan has more than 17 years’ experience in the options industry as a market maker, Options Institute instructor and author of “Trading Option Greeks.”