Break Out the Lumber on This Covered Call

Lumber Liquidators' upward run could continue unchecked

   

Break Out the Lumber on This Covered Call

Hurricane Sandy has ravaged a good part of the eastern seaboard and has devastated properties. Fortunately, some made it through the storm unscathed — but others were not as fortunate. Americans have been resilient in the past when it comes to picking themselves up and rebuilding, however, and a few companies can help with that process.

Here is a covered call trade idea on a stock that looks to be building even higher:

LL110112 300x136 Break Out the Lumber on This Covered Call
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Lumber Liquidators (NYSE:LL) is a wood flooring retailer that might have some more business coming its way very soon. After all, water is not kind to wood flooring.

But before the storm, the company had been posting some impressive numbers. The company reported earnings Oct. 24 and beat expectations on revenues and earnings per share.

Technically, Lumber Liquidators has been slowly climbing for the better part of a year, which is incidentally a great attribute for a stock to have for a covered call strategy. The stock just recently set its all-time high ($58.80), which means there is nothing standing in the way for LL stock to keep moving higher — water or no water.

(LL:NYSE)$55.82

Example: Buy 100 shares of LL @ $55.82 and sell the December 60 call @ 1.15.
Cost of the stock: 100 X 55.82 = $5,582 debit.
Premium received: 100 X 1.15 = $115 credit.
Maximum profit: $533 — that’s $418 (60 – 55.82 X 100) from the stock and $115 from the premium received if LL finishes at or above $60 @ December expiration.
Breakeven: If LL finishes at $54.67 (55.82 – 1.15) @ December expiration.
Maximum loss: $5,467, which occurs in the unlikely event that LL goes to $0 @ December expiration.

Trade Management

The best-case scenario for this covered call strategy is for Lumber Liquidators stock to just rise up to the sold call’s strike price ($60) by December expiration. The stock moves up the maximum amount without being called away because of the short strike, and gains are enjoyed on the shares and the option premium. The process can be duplicated for the next expiration if so desired using either the same $60 strike or a higher strike if LL looks like it will continue to move higher.

If LL makes a move above its all-time high and past the $60 strike well before December expiration — which is a possibility with more than 50 days left until expiration — you could buy the call option back and a higher strike could 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, especially if stock moves higher.

If the upward trend doesn’t continue and 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.


Article printed from InvestorPlace Media, http://investorplace.com/2012/11/break-out-the-lumber-on-this-covered-call/.

©2014 InvestorPlace Media, LLC

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