Everyone likes to get holiday presents — especially when they’re a surprise. Today’s covered call idea might just be a terrific present for investors and shareholders alike.
As reported by Barry Cohen of InvestorPlace.com on Monday, Amgen Inc. (NASDAQ:AMGN) had a major surprise. CEO Kevin Sharer announced he would step down in May. It seemed like investors liked this gift, as shares were up over 4% Thursday and Friday last week.
AMGN develops, manufactures and delivers human therapeutics. The company operates all over the world and has started implementing some cost-cutting measures. It has also started increasing the company’s share-buyback program and has started to pay dividends.
The theory on this covered call trade idea is this:
Since the beginning of October, AMGN has been basically trading in a range from $55 to $59. After the announcement, the stock moved over the $60 area. The stock might come back down to test the prior resistance at $59 before hopefully heading higher. Selling the AMGN Jan 62.50 Call against a long-stock position will give the stock some room to profit if it does head higher.
Making the AMGN Covered Call Trade
With AMGN trading here at $61.16, you could…
Example: Buy 100 shares of AMGN @ $61.16 and sell the Jan 62.50 Call @ 85 cents
Cost of the stock: 100 X $61.16 = $6,116 debit
Premium received: 100 X 85 cents = $85 credit
Maximum profit: $219 — that’s $134 ($62.50 – $61.16 X 100) from the stock and $85 from the premium received if AMGN finishes at or above $62.50 @ January expiration.
Breakeven: If AMGN finishes at $60.31 (61.16 – 0.85) @ January expiration.
Maximum loss: $6,031, which occurs in the unlikely event that AMGN goes to $0 @ January expiration.
Managing the AMGN Covered Call Trade
The main objective for a covered call strategy is for the stock to rise up to the sold call’s strike price at expiration, which in this case is $62.50. 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 surprises and moves past $62.50 and looks like it’s going to go much higher, then the call that was previously sold (Jan 62.50 Call) 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.
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.