by John Kmiecik | August 16, 2012 9:34 am
We’re in the doldrums of summer, when trading and volume are extremely light. It could be that a lots of traders are on vacation, and if you have children, one destination may be the most popular. Not only can it be fun for kids, it can also be fun — and profitable — for traders.
Here’s a covered call trade idea that might leave you feeling like a kid again, but with more money in your pocket.
The theory on this covered call trade example is this:
Disney (NYSE:DIS) reported earnings last week and posted solid gains across its vast empire. Disney has several businesses including media, film entertainment, parks and resorts, and consumer products. Almost half of its income comes from ESPN and related sports channels. ESPN charges a subscription fee that’s the industry’s highest.
Disney also has done better in the movie business with several recent box-office hits under its belt. And despite the slow economy, the parks and resorts have fared well, too.
Technically, the stock has been setting higher pivot highs and higher pivot lows since the beginning of April, constituting a strong uptrend. The stock has never been higher, and with nothing but blue skies overhead, who knows how far this entertainment giant can go?
Example: Buy 100 shares of DIS @ $49.89 and sell the September 52.5 call @ 20 cents
Cost of the stock: 100 X $49.89 = $4,989 debit
Premium received: 100 X 20 cents = $20 credit
Maximum profit: $281 that’s $261 ($52.50 – $49.89 x 100) from the stock and $20 from the premium received if DIS finishes at or above $52.50 @ September expiration.
Breakeven: If DIS finishes at $49.69 ($49.89 – 20 cents) @ September expiration.
Maximum loss: $4,969, which occurs in the unlikely event that DIS goes to $0 @ September expiration.
What we would like to see happen on 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 $52.50. The stock moves up to the strike price without being called away, and gains are enjoyed on the shares and the option premium.
With over 30 days left until expiration, there’s a chance DIS can rise faster than anticipated and beyond the 52.5 strike. If that happens, 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 had no positions in any security mentioned here.
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