Every now and then opportunities appear in the options market that are too good to pass up. My favorites are plays where you can generate larger-than-usual premiums selling covered calls or naked puts. Three just popped up this week, and
First up is J.C. Penney (NYSE:JCP). Nothing makes a stock more volatile, and its option premiums higher, than controversy. Right now, Penney is struggling with its turnaround plan under CEO Ron Johnson. Personally, I have faith in Johnson and in his benefactor Bill Ackman, the hedge fund manager who saw enough value in Penney to buy 26% of the company.
The market, however, is screaming bloody murder. The stock has taken a big hit, down some 50% from its high, and is now range-bound between $19 and $24. But it moves 2% to 3% nearly every day, resulting in juicy volatility. I think the stock will continue trading like this for awhile.
So, I suggest you buy the stock and then sell the next dollar call strike one month out. At this moment, the stock is at $23.34, with September 24 Calls at $1.34. That’s an unheard-of 6% premium, plus another 3% if the stock is called away, for a 9% total return.
Or you could sell September 23 naked puts for $1.36, for a total return of 7.5%. I’d keep rolling these options over every month.
If you’re thinking very long term, sell the January 2014 $15 naked puts for $2.40. First, you’re protected if the company’s value falls by yet another 50% in the next 18 months — all the way down to $12.60. If not, you lock up a 16% return.
Starbucks (NASDAQ:SBUX) is back on my radar because the company’s new growth initiatives seem to be working. I like this play because Starbucks isn’t going anywhere. An options trade could go horribly wrong, but if you own the underlying stock, you will eventually make that money back. With the stock still exhibiting decent volatility, premiums remain generous.
With the stock currently at $46.58, you could buy the underlying and just hold it. Or you can do what I like to do with solid companies, which is just keep selling covered calls against your position. If the stock is called away, then you just buy it back and sell the call again.
Right now, the September 47 Call trades at $1.41. If you add in the 42-cent differential between current and strike price, that’s a potential five-week return of $1.83, or 4%. That’s 41% annualized — exactly the kind of return from this option strategy that makes the opportunity so compelling.
I happen to be a fan of First Cash Financial Services (NASDAQ:FCFS), the leading pawnshop operator in Mexico. The play here is to buy an undervalued company with strong cash flow that also exhibits enough volatility to make premiums look good. The theory with buying an undervalued stock is that if you sell a call and the stock drops, it’s not a big deal because the stock itself is undervalued. It should rise over time, and make you your money back.
I’ve done extremely well in First Cash, both holding long, and selling calls against it. The stock is at $40.66. The September 40 Calls are at $2. That’s a $1.34 return if called away, for a 3.4% return — well above my 2.5% target for covered calls. It’s a 5% return if not called away. With an intrinsic value of $53, this has been a great way to generate income for me over many years.
Lawrence Meyers is long FCFS and has written August 40 Calls against his entire position.