by John Kmiecik | July 12, 2012 8:00 am
With the economy showing signs that this long overdue recovery may be slowing down, investors may want to take a break from searching out new stocks for their portfolio. In fact, it might just be time to take a long-overdue vacation.
Despite concerns that economy may be in trouble, the airline industry stocks are doing extremely well. Here’s a covered call trade idea that might just help your portfolio soar and take you to that getaway you’ve been pining for.
The theory on this covered call trade example is this:
Spirit Airlines (NASDAQ:SAVE) provides low-fare airline service to and from South Florida, the Caribbean and Latin America. Just this past May, Spirit reported traffic increased over 11% versus the same time last year. It also expects capacity to be up over 22% in 2012.
The stock is up about 40% for the year. SAVE has been on the rise from the beginning of June after falling prey to the weak market in May. It previously hit an all-time high just above $24 and should have no problem reaching that again if the bullish trend continues.
Currently the stock may be a bit extended, so it may pull back some before looking to climb higher and reach that point.
Example: Buy 100 shares of SAVE @ $22.20 and sell the August 22.5 call @ 90 cents.
Cost of the stock: 100 X 22.20 = $2,220 debit
Premium received: 100 X 90 cents = $90 credit
Maximum profit: $120. That’s $30 (22.50 – 22.20 X 100) from the stock and $90 from the premium received if SAVE finishes at or above $22.50 @ August expiration.
Breakeven: If SAVE finishes at $21.30 (22.20 – 90 cents) @ August expiration.
Maximum loss: $2,130, which occurs in the unlikely event that SAVE goes to $0 @ August expiration.
The perfect scenario 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 $22.50. The stock moves up the maximum amount without being called away, and gains are enjoyed on the shares and the option premium.
If SAVE fails to pull back or continues its rise faster than anticipated, another strategy can be implemented. 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 if stock moves higher.
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.
As of this writing, John Kmiecik has no positions in any securities mentioned here.
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