Will Santa Claus make a bullish appearance and pull this market out of its doldrums? Traders and investors shouldn’t count on it this year like in years past, which makes picking suitable stocks that generate income for you (through covered calls) that much more important.
The strategy will not succeed if the call option sold expires worthless and the underlying stock has lost way more than the premium received. In other words, it’s critical to pick a stock that will hold its ground and, ultimately, provide you with some nice capital gains along the way.
One name we like as a strong covered-call (or buy-write, if you don’t own the stock already) candidate is Questcor Pharmaceuticals Inc. (NASDAQ:QCOR). This biopharma company develops prescription drugs to treat diseases and disorders of the central nervous system.
Recently, the company’s fourth-quarter earnings growth estimate was raised to over 200%. It is probably safe to say that a lot of companies wish they could be in that position!
Since early 2010, QCOR has made a slow and steady move up to where it is currently trading. For the last month, the stock has been trading in a tight range between about $40 and $44.
For this covered call to have a chance to be successful, the $40 area will have to support the stock in case the market or stock decides to head much lower. Picking the $45 strike makes sense since it is close to the high end of the range.
Making the QCOR Covered Call Trade
Here’s how to set up your covered call trade in QCOR…
Example: Buy 100 shares of QCOR @ $42.84 and sell the Jan 45 Call @ $2.65
Cost of the stock: 100 X $42.84 = $4,284 debit
Premium received: 100 X $2.65 = $265 credit
Maximum profit: $481 — that’s $216 ($45 strike – $42.84 X 100) from the stock and $265 from the premium received if QCOR finishes at or above $45 @ January expiration.
Breakeven: If QCOR finishes at $40.19 ($42.84 – $2.65) @ January expiration.
Maximum loss: $4,019, which occurs in the unlikely event that QCOR goes to $0 @ January expiration.
Managing the QCOR 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, which in this case is $45 at January expiration. The stock moves up the maximum amount without being called away and the sold call expires worthless.
Consider exiting the entire trade (stock and short call) to avoid further losses if QCOR falls much below support (about $40). It just so happens that the breakeven point of the trade at expiration is right in that area of support.
Keep this in mind as you trade: Options trading success comes from the love of the markets!
