When a stock establishes a 52-week high, it’s usually an indicator that the shares are heading even higher. But that brings up two questions: How high will it go, and how long will it take to get there?
Normally if the trading action is at least moderately bullish, an option trader might take a more aggressive approach to try and capture profits. If the stock is just slightly bullish, a covered call might just make sense.
American Tower Corp. (NYSE:AMT) is one example of how to play a “slow and steady” stock mover.
AMT, a wireless and broadcast communications infrastructure company, has recently qualified to start operating as a Real Estate Investment Trust. It has pretty solid fundamentals with a possible weakness in net income growth. That being said, the company has a P/E ratio of 87 and many analysts have a favorable opinion of the company.
The theory on this covered call trade example is this:
As mentioned above, AMT just recently set a new 52-week high. The stock has been on a slow and grinding uptrend since the end of August, setting higher highs and higher lows for the most part.
If the stock continues to trade in this pattern, it should be able to keep trending higher ever so slightly, which can be advantageous if you’re using the covered call strategy.
Making the AMT Covered Call Trade
With AMT trading here at $61.83, you could …
Example: Buy 100 shares of AMT @ $61.83 and sell the Feb 62.50 Call @ $1.10
Cost of the stock: 100 X $61.83 = $6,183 debit
Premium received: 100 X $1.10 = $110 credit
Maximum profit: $177 — that’s $67 ($62.50 – $61.83 X 100) from the stock and $110 from the premium received if AMT finishes at or above $62.50 @ February expiration.
Breakeven: If AMT finishes at $60.73 ($61.83 – $1.10) @ February expiration.
Maximum loss: $6,073, which occurs in the unlikely event that AMT goes to $0 @ February expiration.
Managing the AMT 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.
In the unlikely event the stock aggressively moves past $62.50 and looks like it’s going to go much higher, then the call that was previously sold (February $62.50) 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 below the breakeven point or more than anticipated, it might make sense to close out the entire trade (stock and short call) to avoid further losses.