As a trader or investor, you have probably been told at one time or another that you need to diversify your portfolio. This isn’t always such a bad thing depending on market timing.
The same can be said of companies. Yes, a company should figure out what it does best and stick to it. And sometimes, companies diversify themselves too much and end up selling off their weak links. But when it’s done right, adding businesses that complement their current operations is the way to preserve and enhance profitability.
Here is a company that looks to have some solid profit-producing companies under its belt … and a trade designed to garner you some short-term gains as well.
Textron (NYSE:TXT) has a diversified business model. Founded in 1923, the company owns such businesses as Bell Helicopter, Cessna and E-Z-GO, spanning the range between a variety of aircraft and vehicles.
Its fourth-quarter earnings per share of 49 cents beat estimates. The EPS is expected to grow almost 40% in 2012 and then by another 20% in 2013.
The stock had been trading sideways for the most part for the last half of 2011. Since the new year began, the stock has moved up, especially after earnings were announced in late January. The next resistance for the stock is right above the $28 area, making this a good time to establish a covered-call trade.
Making the TXT Covered Call Trade
With TXT trading here at $26.36, you can…
Example: Buy 100 shares of TXT @ $26.36 and sell the TXT March 28 Call @ 48 cents
Cost of the stock: 100 X $26.36 = $2,636 debit
Premium received: 100 X 48 cents = $48 credit
Maximum profit: $212 — that’s $164 ($28 strike – $26.36 X 100) from the stock and $48 from the premium received if TXT finishes at or above $28 @ March expiration.
Breakeven: If TXT finishes at $25.88 ($26.36 – 48 cents) @ March expiration
Maximum loss: $2,588, which occurs in the unlikely event that TXT goes to $0 @ March expiration
Managing the TXT Covered Call Trade
In most cases, 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 $28. 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 event TXT surges past the $28 area, which is the strike that was sold, and it looks like it will go much higher, then you can buy back the call that you previously sold (the March 28 Call) and sell a higher-strike call against the shares to avoid assignment. This allows the stock to remain in the portfolio and also gives the position a chance to increase its return.
The eight-day simple moving average has acted as support for the stock in the past. In case the stock does decline, it will likely act in that capacity again. Currently it is just below the current price.
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.