A strategy idea for options trading investors.
Covered calls are generally viewed as a conservative strategy utilized by professional and retail investors and traders. The general approach with a covered call is to find a stock that is neutral to slightly bullish. The current market has been extremely choppy and mostly bearish over the last week or so. Will the run continue to the downside or will the market breakout of its funk? Obviously, nobody is certain and that is why a covered call is so nice because it does offer some downside protection. Let’s see what looks good this week.
The stock we are looking at today is Fossil Inc. (NASDAQ: FOSL). Over the last two and a half years FOSL has gone from about $12 to its current price of about $129. It has gone sideways every so often for a month or so but it hasn’t made a habit of this behavior. The stock might be a little expensive for some traders or investors but the company is quite sound fundamentally.
The theory on this covered call trade example is this:
FOSL gapped up over $100 at the beginning of May. For a month it tried to breakdown below that $100 level and could not do it. Since then it has been on a tear up and has not slowed down. The stock now has no resistance ahead. Like all covered call strategies, traders and investors worry that the market will be extremely bearish and try and drag the stock down with it. Of course on a somewhat bullish strategy, that is always a concern. August expiration has a little less than 40 days until the options expire. This FOSL covered call trade is structured more for maximizing returns on a stock position but still gives the position some downside protection in this turbulent market. Remember – every trade should have defined risk and loss parameters in place.
Fossil Inc. (FOSL) – $129.02
Example: Buy 100 shares of FOSL @ $129.02 and sell the FOSL August 135 Call @ $3.90
Cost of the stock: 100 X $129.02 = $12,902 debit
Premium received: 100 X 3.90 = $390 credit
Maximum profit: $988. If FOSL finishes at or above $135 @ August expiration, the investor receives $598 from the move up in the stock from 129.02 to 135, and $390 from the option premium received.
Breakeven: If FOSL finishes at $125.12 (129.02 – 3.90) @ August expiration.
Maximum loss: $12,512 if FOSL goes to $0 @ expiration.
The goal for any covered call strategy is for the stock to rise up to the strike price of the sold call, in this case $135. The stock moves up the maximum amount without being called away and the sold call expires worthless.
As always, if the stock moves past $135 and looks like it’s not going to slow down, then the Aug 135 call can be bought back and a higher strike can be sold against the position.
This will allow the stock to remain in the portfolio and also give the position a chance to increase its return. The way this stock has been performing, it’s certainly a possibility. If FOSL declines severely, the stock can be sold and the option can be bought back to reduce losses.
The company announces earnings on August 9th. If the position is profitable before earnings, profits can be taken since earnings can be unpredictable.
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.”