A strategy idea for options trading investors.
Deciding whether or not to open a covered call position in this type of market can be a challenge for some traders and investors. The general thought on the covered call is to find a stock that is stagnant but slightly bullish. The current market has been extremely bullish over the last week or so. Will the run continue or will the market pullback some? Obviously, nobody is certain and that is why a covered call is nice because it offers some downside protection. Let’s see what looks good this week.
Panera Bread Co. (NASDAQ: PNRA) has had a nice run for the last two years going from about $50 to its current price of about $130. Since the middle of February the stock has been going sideways between $115 and $130. The stock might be a little expensive for some but the company is very sound fundamentally.
The theory on this PNRA covered call is this:
Since a June pull back PNRA has been on a tear and on Friday, July 1 it broke some slight resistance and closed above $130 for the first time ever. The stock now has nothing but blue skies above. The only worry is the broader market. There are less than 10 days left for the July options so let’s look for August expiration calls. This will give the stock a longer time to rise and provide us with some additional premium. This PNRA covered call trade is structured more for protecting the stock in case it takes a dip down, but it also enhances our return if the stock stands strong.
Panera Bread Co. (PNRA): $131.15
Example: Buy 100 shares of PNRA @ $131.15 and sell August 135 Call @ $3.40
Cost of the stock: 100 X $131.15 = $13,115 debit
Premium received: 100 X $3.40 = $340 credit
Maximum profit: $725 — If PNRA finishes at or above $135 @ August expiration, the covered call seller earns $385 (135 – 131.15 X 100) from the stock and $340 from the option premium received.
Breakeven: If PNRA finishes at $127.75 (131.15 – 3.40) @ August expiration.
Maximum loss: $12,775 if PNRA goes to $0 @ expiration.
The goal for any covered call is for the stock to rise up to the sold call’s strike price, 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 that was sold 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 give the position a chance to increase its return. If PNRA for some reason takes a dive south, the stock can be sold and the option can be bought back to reduce losses.
The company is announcing earnings on July 26. If the position is profitable before earnings, profits can be taken since earnings can be unpredictable. Every trade should have defined risk and loss parameters in place.
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.”