A Covered Call Play for Texas-Sized Profits

by John Kmiecik | September 6, 2012 8:03 am

A Covered Call Play for Texas-Sized Profits

The slow and low-volume days of summer are supposedly over in regards to trading. Traders and investors are back from their vacations and are ready to get back to business. The real question is, are you ready to get back to business and increase the new worth of your portfolio? If you are, then here is a covered call trade idea that could deliver a better return than most banks.

The theory on this covered call trade example is this:

Texas Capital Bancshares (NASDAQ:TCBI[1]) operates as the holding company for Texas Capital Bank. The company provides banking products and services to commercial and high-net-worth clients in Dallas and other Texas counties. Fortunately for the company, the Texas economy has been relatively strong compared to most others. TCBI last announced earnings in late July, and net income increased 9% on a linked-quarter basis and increased 77% year-over-year.

TCBI stock has more than doubled in price since October 2011 and has done it in a manner that is conducive to covered call strategies — slow and steady. The stock has been continually moving higher, pulling back, then making new highs. Since the stock has never been higher before, there is no reason to believe that it cannot move higher. If it continues in the manner in which it has been climbing, this trade idea might produce some Texas-size profits.

TCBI$45.69

Example: Buy 100 shares of TCBI @ $45.69 and sell the October 50 call @ 40 cents
Cost of the stock: 100 X 45.69 = $4,569 debit
Premium received: 100 X 0.40 = $40 credit
Maximum profit: $471 — that’s $431 (50 – 45.69 X 100) from the stock and $40 from the premium received if TCBI finishes at or above $50 @ October expiration.
Breakeven: If TCBI finishes at $45.29 (45.69 – 0.40) @ October expiration.
Maximum loss: $4,529, which occurs in the unlikely event that TCBI goes to $0 @ October expiration.

Trade Management

The ultimate profit 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 $50. The stock moves up to the strike price without being called away and gains are enjoyed on the shares and the option premium.

Since there are more than 40 days until expiration, there is a chance that TCBI might rise faster than anticipated and past the $50 strike price. If that happens, the call option (October 50) 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 did not hold a position in any of the aforementioned securities.

Endnotes:
  1. TCBI: http://studio-5.financialcontent.com/investplace/quote?Symbol=TCBI

Source URL: http://investorplace.com/2012/09/a-covered-call-play-for-texas-sized-profits-tcbi/
Short URL: http://invstplc.com/1nxrCZ2