Traders, Cover Yourself With ASH

Ashland Inc. might be ripe for a covered call play

   

When searching for potential call candidates, it’s often important to look for strong stocks within a strong sector. It also can be important for that sector to have less cyclicality, which might cause the stock’s price to have major swings. Here is a trade idea from the specialty chemicals sector that might just make sense.

The theory on this covered call trade idea is this:

Ashland (NYSE:ASH) operates a specialty chemicals company in the U.S. and internationally. The company has multiple strengths such as revenue growth, solid cash flow and reasonable debt levels. As of last week, nine analysts rated ASH as a buy, with no analysts rating the stock as a hold or sell.

The stock is up about 16% year-to-date after being in a slight downtrend in February and March of this year. The stock recently has been hanging around a resistance level right around $67. If the stock can break and hold that level, its next level of resistance would be around $75 (previous high), which makes this stock a nice candidate to go higher and for a covered call.

ASH: $66.60

  • Example: Buy 100 shares of ASH @ $66.60 and sell the June 70 call @ 85 cents
  • Cost of the stock: 100 X 66.60 = $6,660 debit
  • Premium received: 100 X 0.85 = $85 credit
  • Maximum profit: $425 that’s $340 (70 – 66.60 X 100) from the stock and $85 from the premium received if ASH finishes at or above $70 @ June expiration.
  • Breakeven: If ASH finishes at $65.75 (66.60 – 0.85) @ June expiration.
  • Maximum loss: $6,575 which occurs in the unlikely event that ASH 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 $70. The stock moves up the maximum amount without being called away, gains are enjoyed on the shares and the sold call expires worthless.

If in fact ASH breaks its resistance at $67 and becomes very bullish, there is a strategy a trader or investor can execute. If the stock looks like it will go much higher than $70, the 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. The market has not been overly bullish lately (to say the least), but there is always that possibility.

If the stock drops in price more than was anticipated, it might make sense to closeout the entire trade (stock and short call) to possibly avoid further losses.

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


Article printed from InvestorPlace Media, http://investorplace.com/2012/05/traders-cover-yourself-with-ash/.

©2014 InvestorPlace Media, LLC

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