Looking for a covered call candidate in this market can be rather difficult. Few stocks are able to hold their own and not drop in price, and even fewer are able to advance in this market. The financial sector is one that has been particularly hurt by this latest bearish drop, but one company might look like a solid choice.
The theory on this covered call trade example is this:
BB&T Corp. (NYSE:BBT) operates as a financial holding company for Branch Banking and Trust Company, which provides banking services for commercial and retail customers. BBT has been able to generate decent returns on equity of 9% over the past year — solid for a bank — and generally has noteworthy fundamentals. Plus, the CEO has been with the bank for more than 30 years and in his current position since 2008. There’s a man that is committed to his career!
The stock is up about 20% year-to-date and recently has pulled back to a level of support around $30. Yes, it has declined in value like many stocks, but if BBT can hold that support area, it has a chance to move to a recent high at just over $32. If you are thinking even more long-term than that, its all-time high is just above $44.
Example: Buy 100 shares of BBT @ $30.16 and sell the July 32 call @ 0.50.
Cost of the stock: 100 X 30.16 = $3,016 debit.
Premium received: 100 X .50 = $50 credit.
Maximum profit: $234 — that’s $184 (32 – 30.16 X 100) from the stock and $50 from the premium received if BBT finishes at or above $32 @ July expiration.
Breakeven: If BBT finishes at $29.76 (30.16 – .50) @ July expiration.
Maximum loss: $2,976, which occurs in the unlikely event that BBT goes to $0 @ July expiration.
The main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price at expiration, which in this case is $32. 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 BBT breaks its pattern of slowly rising and looks to head much higher than $32, there is a strategy a trader or investor can implement. The call option can be bought back and a higher strike can be sold against the position to avoid assignment. Considering there are more than 50 days until expiration, this is a possibility. 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.
Remember to always think about how you will manage the trade before implementing it, even if just paper-trading.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.