Many investors consider a stock reaching five-year highs a special occasion, but where it goes from there can be a really special event — especially if the investor is bullish.
The following covered call trade idea focuses on a stock that is doing just that: flirting with its long-time highs.
Banking giant JPMorgan Chase (NYSE:JPM) is well-known by many people and is generally regarded well by many analysts. The bank suffered last spring amid the “London Whale” incident, but it has since recovered and actually moved higher than where it was trading before the monster loss was revealed.
Click to Enlarge As mentioned earlier, JPM is looking to make a new five-year high and recently broke through resistance (several previous pivot highs) right around $48. The next area of resistance JPMorgan might face will be around $52, which was a pivot high set back in early 2007.
The Trade (NYSE:JPM, $48.61)
Example: Buy 100 shares of JPM @ $48.61 and sell the March 50 call @ 44 cents.
Cost of the stock: 100 X 48.61 = $4,861 debit.
Premium received: 100 X 0.44 = $44 credit.
Maximum profit: $183 — that’s $139 (50 – 48.61 X 100) from the stock and $44 from the premium received if JPM finishes at or above $50 @ March expiration.
Breakeven: If JPM finishes at $48.17 (48.61 – 0.44) @ March expiration.
Maximum loss: $4,817, which occurs in the unlikely event that JPM goes to $0 @ March expiration.
The maximum profit potential for this covered call strategy is for JPM to just rise up to the sold call’s strike price ($50) by March expiration next month. The stock moves up the maximum amount without being called away and profits 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 50 strike if the outlook on the stock or market is neutral, or a higher strike if the outlook continues to be slightly bullish.
If JPM rises faster than anticipated before March expiration, the 50 strike call option can be bought back and a higher strike with a March or later expiration 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 especially if stock moves higher.
The breakeven point of this trade is just above support at the $48 area (previous resistance), which should help the stock from falling. 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 avoid further losses.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.