A Bullish Play on a Chinese Gaming Site

by John Kmiecik | May 24, 2012 9:05 am

A Bullish Play on a Chinese Gaming Site

There’s plenty of investment interest when in comes to Internet stocks. Sure, you have your big names like Google (NASDAQ:GOOG[1]) and Baidu (NASDAQ:BIDU[2]), but another one out there has a pretty impressive record, too. While most Internet companies have faltered as of late — not to mention Facebook[3]‘s (NASDAQ:FB[4]) rough start — this one seems to be getting stronger, and it might just make a nice covered call.

The theory on this covered call trade idea is this:

NetEase (NASDAQ:NTES[5]) is a Chinese provider of an interactive online gaming community, an Internet portal and wireless value-added services. The company has impressive fundamentals, including trading at over 15 times past earnings and over $2 billion in cash with zero debt.

The stock just recently hit an all-time high after posting better-than-expected earnings. It’s up about 240% over the past five years and has moved from about $42 to about $60 in the last six months. This covered call trade idea allows the stock to move higher and still lets the trade to take advantage of selling premium.

NTES ($59.70)

Example: Buy 100 shares of NTES @ $59.70 and sell the June 62.5 call @ 1.35

Cost of the stock: 100 x 59.70 = $5,970 debit

Premium received: 100 x 1.35 = $135 credit

Maximum profit: $415. That’s $280 (62.5059.70 x 100) from the stock and $135 from the premium received if NTES finishes at or above $62.50 @ June expiration.

Breakeven: If NTES finishes at $58.35 (59.70 1.35) @ June expiration.

Maximum loss: $5,835 which occurs in the unlikely event that NTES goes to $0 @ June expiration.

Trade Management

The best case for a covered call is for the stock to rise just 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, and profits are enjoyed on the shares and the sold call expires worthless.

If NTES breaks its previous high at just above $63 and continues to move up, there’s a strategy for that. The 67.5 call option 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 possibly avoid further losses.

Endnotes:
  1. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  2. BIDU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BIDU
  3. Facebook: http://investorplace.com/hot-topics/facebook/
  4. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  5. NTES: http://studio-5.financialcontent.com/investplace/quote?Symbol=NTES

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