The market’s recent volatility has given more than a few traders some headaches, and swing trading (two to five days) has been particularly difficult in this trading environment. However, this covered call idea might just keep traders driving in a profitable position for a long time:
Avis Budget Group (NASDAQ:CAR) is known for renting cars and trucks to businesses and consumers worldwide. Is Avis better than Hertz (NYSE:HTZ) as far as service goes? That’s for consumers to decide — but the real difference has been in the stock performance.
Click to Enlarge Avis has trended higher by more than 50% during the past six months. In fact, looking at the chart, a trader would be hard-pressed to see much of a pullback in the stock’s price over that time period. The stock is currently trading close to its 52-week high, but it still has a lot more room to move higher based on its all-time high of over $50 it hit back in 1998.
On Wednesday, CAR broke through a resistance area at $28. As long as this stock remains in its current pattern of slowly trending higher for the most part — which is perfect for a covered call strategy — there is no reason it should not be able to challenge that high again someday.
Avis (NASDAQ:CAR): $29.13
Example: Buy 100 shares of CAR @ $29.13 and sell the May 31 call @ 70 cents.
Cost of the stock: 100 X 29.13 = $2,913 debit.
Premium received: 100 X 0.70 = $70 credit.
Maximum profit: $257 — that’s 187 (31 – 29.13 X 100) from the stock and $70 from the premium received if CAR finishes at or above $31 @ May expiration.
Breakeven: If CAR finishes at $28.43 (29.13 – 0.70) @ May expiration.
Maximum loss: $2,843, which occurs in the unlikely event that CAR goes to $0 @ May expiration.
The best profit scenario for this covered call is for Avis to just rise up to the sold call’s strike price ($31) at May expiration. 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 31 strike if the outlook on the stock is neutral or a higher strike (maybe 32 or higher) if the stock looks like it wants to head higher.
Since there are over 30 days until May expiration, there is a chance that CAR might try to move past $31 well ahead of expiration even on its slow pace if the market continues to surge. If that happens, the 31 strike call option can be bought back and a higher strike with May or a later expiration can be sold against the position to avoid assignment. Considering these options have $1 strike increments, it gives traders multiple strikes to choose from. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return, especially if Avis moves higher.
Every trader needs to determine for himself when to cut their losses if the stock drops in price, but the breakeven point of the trade or the stock’s support area should be considered. It probably would make sense to close out the entire trade (stock and short call) to avoid further losses at one of those points.
As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.