by John Kmiecik | March 29, 2012 9:41 am
Summer is coming, and who doesn’t want to look good? More now than ever, it seems there is more of a concern to look young and feel better, especially when wearing summertime threads that leave less to the imagination.
Funny enough, the same can be said of your portfolio. Who doesn’t want to look and feel better about their financial outlook? A healthy and profitable portfolio could make an investor’s skin glow just like this covered-call trade idea.
Nu Skin Enterprises Inc. (NYSE:NUS) manufactures and distributes skincare products under its Nu Skin brand and nutritional supplements under its Pharmanex brand. The company pays an attractive dividend and sales have accelerated for two straight quarters. NUS has a solid price-to-earnings ratio of more than 23 — above the industry average — and recently announced a fresh line of anti-aging products.
The stock is up more than 20% for the year and has formed a solid bullish trend, recently rallying to a new all-time high. Just this week, the market has pulled back and so has NUS.
The stock has a support area right around $58, which was a previous base that should be able to stop the stock from falling much below that area (barring an overall market collapse). The stock should recover nicely from this temporary drop and look to move higher once again.
For this covered call trade idea, you would buy 100 shares of NUS at $59.46 and sell one April 60-strike call for a premium of $1.10 (or better, if you can get it). The cost of the stock position is $5,946 and this is offset by the $110 credit, making the overall cost of the strategy $5,836.
The maximum profit, should NUS rally up to or beyond $60 by expiration, is $164, which is a $54 gain in the stock from its current price to the strike price plus the $110 credit collected from selling the call. Above 60, the shares will likely be called away, meaning the trader surrenders any upside past this point.
Maximum loss is $5,836, or the cost of the 100 shares less the call premium. This would only occur in the unlikely event that NUS plunges to $0 in the next 22 days (and the position is left open). Breakeven for this strategy is $58.36. If the stock is trading anywhere above this level when April options expire, the covered call is profitable.
If everything goes as planned, the best possible outcome and maximum profit potential for a covered call is for the stock to advance just to the sold call’s strike price at expiration, which in this case is $60. The shares move up the maximum amount without being called away and gains are enjoyed on the stock as well as the call option, which expires worthless.
In the event NUS begins to rally past the $60 area with signs that it will continue to rise, the call that was previously sold (April 60) can be bought back and a higher strike can be sold against the position to avoid assignment. This allows the stock to remain in the portfolio and also give the position a chance to increase its return. With NUS trading around its all-time high, this could be a possibility.
The breakeven point of this covered call is at $58.36, which is just above the support area around $58. If all things go well with this trade idea, this will be a non-factor but it is nice to have a level of support close to the area you do not want the stock to breach.
If the stock drops in price more than was anticipated, it probably makes sense to close out the entire trade (stock and short call) to possibly avoid further losses.
As of this writing, John Kmiecik does not own any shares mentioned here.
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