by John Kmiecik | November 29, 2011 11:00 am
We have the Super Committee, the International Monetary Fund and the Federal Reserve. Yet, can one of these organizations, let alone all of them combined, solve all the world’s problems?
The answer is probably no, but one can only hope … and hope is a word that should never be used by a trader or investor. You should always have a plan in place before executing a trade, and this applies to covered calls as well. Here is one example to ponder.
Tractor Supply Co. (NASDAQ:TSCO) looks like it could be a great choice for a covered call (or a buy-write, if you don’t already own the shares). The company operates over 1,000 farming equipment stores in over 40 states and plans on opening another 80 by the end of this year.
The company looks good on paper and is expected to grow earnings about 20% over the next four quarters. With this economy, that is quite a feat.
Since the beginning of October, TSCO has had a nice move up and has been trading in a range between about $68 and $75 for the past month and a half. With the current volatility and market conditions, it might be difficult for TSCO to really break out to the upside.
The $68 low-end of the range should act as a nice area of support to keep the stock from declining. This covered-call idea is counting on this stock to continue to trade in that range and be closer to the $70 area at December expiration.
Making the TSCO Covered Call Trade
With TSCO trading here at $68.85, you could buy 100 shares and sell the TSCO Dec 70 Calls against them for a $1.95 credit. Here’s a breakdown of this trade…
Cost of the stock: 100 X $68.85 = $6,885 debit
Premium received: 100 X $1.95 = $195 credit
Maximum profit: $310 — that’s $115 ($70 option strike – $68.85 stock price X 100) from the stock and $195 from the premium received if TSCO finishes at or above $70 @ December expiration.
Breakeven: If TSCO finishes at $66.90 ($68.85 – $1.95) @ December expiration.
Maximum loss: $6,690, which occurs in the unlikely event that TSCO goes to $0 @ December expiration.
Managing the TSCO 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 $70, at December 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 TSCO falls much below support (about $68). Your No. 1 goal as a trader or investor is to preserve your capital!
Remember, he or she who fails to plan, plans to fail.
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