Give Into Dollar General’s Trading Temptation

by John Kmiecik | May 17, 2012 8:13 am

Are there bonus points for investing in a company that makes charitable contributions? There aren’t, but maybe there should be. This company recently awarded more than $6.4 million in grants to almost 600 nonprofit organizations.

What makes this company maybe even more desirable is its stock record. It has shown the propensity to increase over time and it may make it a desirable idea for a covered call.

The theory on this covered call trade example is this:

Dollar General (NYSE:DG[1]) operates more than 9,000 discount merchandise stores in 35 states and plans on opening about another 7% by the end of 2012. Right now, it has more stores than any U.S. retailer and it is doing well enticing recession-plagued shoppers.

Since the company went public in late 2009, the stock has been increasing ever so slowly over time. Just last week it hit an all-time high and has dropped in price but still has maintained its uptrend. Selling the June 49 strike seems like the logical choice since that is just below the last pivot high ($48.74).

If the economy continues in this funk, there is no reason DG can’t continue to thrive, stock and company.

DG: $47.61

• Example: Buy 100 shares of DG @ $47.61 and sell the June 49 call @ 0.95.
• Cost of the stock: 100 X 47.61 = $4,761 debit.
• Premium received: 100 X .95 = $95 credit.
• Maximum profit: $234 — that’s $139 (49 – 47.61 X 100) from the stock and $95 from the premium received if DG finishes at or above $49 @ June expiration.
• Breakeven: If DG finishes at $46.66 (47.61 – .95) @ June expiration.
• Maximum loss: $4,666, which occurs in the unlikely event that DG goes to $0 @ June expiration.

Trade Management

The main objective for a covered call is for the stock to just rise up to the sold call’s strike price at expiration, which in this case is $49. 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 DG continues its trend of making new all-time highs, there is a strategy a trader or investor can implement. If the stock looks like it will rise much higher than $49, the call option can be bought back and a higher strike can be sold against the position to avoid assignment. Considering there are about 30 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.

Trade smart!

As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2012/05/give-into-dollar-generals-trading-temptation/

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