How long will this market continued to be affected by the European debt and banking crisis? Who knows for sure, but the answer is probably too long unfortunately. Finding a suitable trading candidate in this market may take a little more time to research.
If you only use technical analysis when choosing your trades, you might want to do some fundamental research as well before you enter any new positions. A nice non-bearish trend can be disrupted with some unexpected, perceived bad news that can drive shares lower.
A stock whose company has solid fundamentals may not be immune to a drop in price, but it may help the stock eventually recover a little quicker than a company with poor fundamentals.
EOG Resources Inc. (NYSE:EOG) looks like a great candidate for a covered-call (buy-write) trade this week. EOG is one of the largest independent oil and natural gas companies in the United States, with reserves in the U.S., Canada, Trinidad, the United Kingdom and China.
The company looks solid financially with increasing revenue growth, expanding profit margins and a nice growth in net income. And this week, TheStreet Ratings upgraded the stock, while UBS research analysts raised their EPS estimates on EOG as well.
It’s no wonder, as this company has pretty solid fundamentals.
Since the beginning of October, the stock has gone from below $70 to its current price ($102.36). Just this month, the stock finally got above its 200-day moving average and has basically traded sideways since.
EOG may continue to trade sideways for sometime before the stock continues to move higher. This occasionally happens after a breakout. The stock has traded much higher than its current price, so expecting the stock to continue to rise eventually is within reason.
Making the EOG Covered Call Trade
Example: Buy 100 shares of EOG @ $102.36 and sell the EOG Dec 105 Call @ $3.95
Cost of the stock: 100 X $102.36 = $10,236 debit
Premium received: 100 X $3.95 = $395 credit
Maximum profit: $659 — that’s $264 ($105 – $102.36 X 100) from the stock and $395 from the premium received if EOG finishes at or above $115 @ December expiration.
Breakeven: If EOG finishes at $98.41 ($102.36 – $3.95) @ December expiration.
Maximum loss: $9,841, which occurs in the unlikely event that EOG goes to $0 @ expiration.
Managing the EOG Covered Call Trade
The main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price at expiration, which in this case is $105. The stock moves up the maximum amount without being called away, gains are enjoyed on the shares and the sold call expires worthless.
If the stock moves past $105 and looks like it’s going to go much higher, then the call that was previously sold (December 105) can be bought back and a higher strike can be sold against the position to avoid assignment. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return.
The breakeven point on this covered call is close to an area of support for the stock, which is the $98 area.
If the stock drops in price more than was anticipated, it might make sense to close out the entire trade (stock and short call) to avoid further losses.