by John Kmiecik | November 9, 2011 8:00 am
Ulta Salon Cosmetics and Salon Inc. (NASDAQ:ULTA) looks like it might be a beautiful choice for an options trade this week.
ULTA provides hair care products and accessories, cosmetics and salon services. It operates and franchises upward of 400 stores in 42 states. The company has solid fundamentals, and shares are up almost 100% for the year.
ULTA has been trading in a range between about $66 and $74 for the better part of two months. The stock just recently hit its 52-week high at just above $75.50.
The stock might pull in a bit before it finally gets through, and holds, the $74 area before it continues higher. This makes ULTA an excellent candidate to own and to, at the same time, generate income by selling calls against it (i.e., the covered call strategy or a buy-write).
If you buy the shares at market (currently trading at $72.40) and then sell the $75-strike calls against them, these options will still give this stock some room to go higher while you pocket income in the meantime.
Because there are fewer than two weeks to go until November expiration, calls with a December expiration date will give this covered call a greater option premium and more time for the stock to hopefully go higher. Plus, you’ll be situated in the trade for ULTA’s Dec. 5 earnings announcement, and you may be able to cash out long before expiration.
Making the ULTA Covered Call Trade
Example: Buy 100 shares of ULTA @ $72.40 and sell the Dec 75 Call @ $4.50
Cost of the stock: 100 X $72.40 = $7,240 debit
Premium received: 100 X $4.50 = $450 credit
Maximum profit: $710 — that’s $260 ($75 strike – $72.40 share price X 100) from the stock and $450 from the premium received if ULTA finishes at or above $75 @ December expiration
Breakeven: If ULTA finishes at $67.90 ($72.40 stock price – $4.50 premium received) @ December expiration
Maximum loss: $6,790, which occurs in the unlikely event that ULTA goes to $0 @ December expiration
Managing the ULTA 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 $75 at expiration. The stock moves up the maximum amount without being called away and the sold call expires worthless, but the trade can be closed out anytime before expiration for profit or loss.
If the stock drops in price more than was anticipated for whatever reason, it might make sense to closeout the entire trade (stock and short call) to avoid further losses.
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