An Options Trade Seated in Pure Logic

by John Kmiecik | September 20, 2012 8:39 am

Sometimes a trade makes so much sense and seems so logical that a trader can question his or her own logic. And today, we have a perfect example.

Here is a stock that has been able to gain in value by being associated with one of the hottest companies of all time. Does this necessarily make it a good investment? Many would argue that it does, so here’s a way traders and investors can possibly profit with a covered call:

Cirrus Logic (NASDAQ:CRUS[1]) makes chips used in audio and energy products and is the sole provider of audio chips for Apple’s (NASDAQ:AAPL[2]) iPhones and iPads. Not a bad position to be in. A few analysts have recently raised their price targets on the stock, citing the company’s strong product association and continuing opportunities with Apple.

Since the company announced earnings in late July, the stock has been slowly climbing higher, which bodes well for a covered call. The next area of resistance the stock faces is a previous pivot high above $47 from more than 10 years ago. There is no reason this stock can’t continue to climb higher.

CRUS — $43.90

Example: Buy 100 shares of CRUS @ $43.90 and sell the October 47 call @ 1.75.
Cost of the stock: 100 X 43.90 = $4,390 debit.
Premium received: 100 X 1.75 = $175 credit.
Maximum profit: $485 — that’s $310 (47 – 43.90 X 100) from the stock and $175 from the premium received if CRUS finishes at or above $47 @ October expiration.
Breakeven: If CRUS finishes at $42.15 (43.90 – 1.75) @ October expiration.
Maximum loss: $4,215, which occurs in the unlikely event that CRUS 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 $47. The stock moves up to the strike price without being called away, and gains are enjoyed on the shares and the option premium.

Since the stock is associated with Apple, there is a decent chance that the stock could rise faster than anticipated and past the $47 strike price by October expiration. If that happens, the call option (October 47) 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.

Keep in mind that CRUS is expected to announce earnings on Oct. 15.

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

Source URL: https://investorplace.com/2012/09/covered-call-cirrus-logic-inc-crus/

---