Option Profits Are as Easy as ABC

by John Kmiecik | March 7, 2013 8:32 am

While people on the right and left of the political fence might argue over how much of a role the U.S. government should have in people’s lives, government intervention is almost certainly a good thing for this particular trade:

AmerisourceBergen (NYSE:ABC[1]) is a pharmaceutical company drugs and related services to healthcare providers and manufacturers primarily in the U.S. and Canada. The company announced earnings late in January that were relatively strong. First-quarter revenues were up 6% to over $21 billion, and EPS improved by 13% to 69 cents. Also, the company paid a 21-cent dividend March 4.

ABC is generally well-regarded among analysts, and back in February, CEO Steve Collis talked about “Obamacare” being a great thing for the company — which is a positive, since it looks like it is here to stay for now.

Looking at the chart, the stock has been in a nice uptrend since about August 2012:

ABCchart1 Option Profits Are as Easy as ABC[2]

AmerisourceBergen has pulled back at times, like most stocks will, but has managed to keep consistently setting new all-time highs. If you take a look at a 10-year chart, the stock has some resistance right around $50 (previous pivot highs and lows) that makes it a great target.

Selling the April 50 call against the stock will be a way to increase the return of the stock if it happens to make it to $50 by April expiration.

(NYSE:ABC)$48.48

Example: Buy 100 shares of ABC @ $48.81 and sell the April 50 call @ 40 cents.
Cost of the stock:
100 X 48.48 = $4,848 debit.
Premium received: 100 X 0.40 = $40 credit.
Maximum profit: $192 — that’s $152 (50 – 48.48 X 100) from the stock and $40 from the premium received if ABC finishes at or above $50 @ April expiration.
Breakeven: If ABC finishes at $48.08 (48.48 – 0.40) @ April expiration.
Maximum loss: $4,808, which occurs in the unlikely event that ABC goes to $0 @ April expiration.

Trade Management

The maximum profit potential for this covered call strategy is for the stock to just rise up to the sold call’s strike price ($50) by April 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 ABC is neutral, or a higher strike if it looks like it will break the $50 resistance area.

If ABC unexpectedly moves past $50 well ahead of expiration, the 50 strike call option can be bought back and a higher strike with April or a 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 the trade is close to a minor support area around $48 that might keep the stock from moving lower. If the upward trend doesn’t continue and the stock drops in price more than was anticipated and below breakeven, 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.

Endnotes:
  1. ABC: http://studio-5.financialcontent.com/investplace/quote?Symbol=ABC
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/03/ABCchart1.png

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