Commonly touted as a gateway strategy, covered calls provide an alluring introduction into the options realm for equities traders looking to not only improve returns, but also to get paid to obtain some downside protection on their investments.
If you’re new to the covered-call strategy, it merely consists of purchasing 100 shares of stock and selling a call option against those shares (as one option contract represents 100 shares). The premium brought in through the sale of the call provides the double benefit of income and downside protection.
One of the ideal times to sell a covered call on an existing stock position is after it has rallied and is perhaps encountering some overhead resistance. With that in mind, Microsoft Corp. (NASDAQ:MSFT) is one such stock that may be ripe for the picking. Let’s take a look at its recent performance to see why.
From the pivotal Thanksgiving low formed on Nov. 25, 2011, MSFT is up 15%. Since the beginning of the New Year, it is up an impressive 7.8% alone.
Yet, if recent history is any indication, MSFT is anything but a momentum stock. The odds of it beginning a rip-roaring uptrend are slim. While it may indeed continue its upward trajectory, it will likely be at a much-slower pace.
MSFT shareholders looking to simultaneously exploit the recent run as well as lower their exposure in the event it falls from these heights should consider selling the MSFT Feb 28 Call options for around 80 cents.
If you don’t own the shares, you can buy them here at market and sell these Feb 28 Calls against them immediately. This transaction is known as a buy-write. You won’t want to sell calls on this or any stock without owning (or buying) the underlying shares.
If the stock continues to power higher in the coming weeks, traders can still capture an additional $80 (80 cents x 100) in their position. On the other hand, if MSFT pulls back in the coming weeks, the 80-cent premium received from the call will offset up to an 80-cent drop in the stock price.
Either way, covered calls currently provide some alluring advantages for traders owning shares of MSFT.
At the time of this writing Tyler Craig had no positions on MSFT.