by Bryan Perry | September 19, 2013 8:34 am
It’s no secret that Ford (F) is hitting on all cylinders with strong domestic and foreign sales that are trending higher on a monthly basis. Ford just announced recently that it is going to build the fast-selling Fusion model here in the United States, a very popular move with investors. The stock made a nice move off of $16 and is putting in a constructive “handle” technical formation that should prompt a move up to $18 or higher by October expiration.
But, while F is poised to move up in the near term, traders are smart to give themselves a measure of protection with any new position. The ideal way to take advantage of a stock’s ascent while minimizing risk is with a buy-write approach. Essentially, a buy-write is a covered call strategy designed to generate safe, short-term gains.
A buy-write involves buying stock shares while also selling a call option against those shares with the intent of getting the stock shares called away. It’s a great way to manufacture “synthetic dividends” on bullish stocks that don’t offer a dividend, or at least not much of one. Consider F’s tepid 2.30% dividend. While that’s average in the marketplace, it’s not good enough to be part of my income lineup for my high-yield income service, Cash Machine. But I don’t want to miss out on the stock’s short-term dash, so if we write a call against the shares, we get exposure to the upside and we stand to make a pretty quick return while also making sure we have some downside protection in place. Here’s my recommendation:
For every 100 shares of Ford that you own or purchase at market, sell one F Oct. $18 Call (third week expiration) at 35 cents or more per contract.
Let’s look at this buy-write covered call in F and how the math works.
Say you buy shares of F at Wednesday’s closing price of $17.62 and you sell the F Oct. $18 Call at 35 cents and collect that premium. That brings your cost basis of your F shares down to $17.27.
If F moves up and through the $18 mark by options expiration on Oct. 18 as I expect it to, the buyer of the F Oct. $18 Calls that we sold to will exercise those options. When this happens, our shares of F that we bought for a cost basis of $17.27 will get called away at the $18 strike price, which is the exit price for the stock. That gives you an easy, stress-free 4.2% return on your money before Halloween rolls around.
Now, the argument with buy-writes is that you cap your upside. That’s true, but the defined profit potential also means that you are mitigating some of your risk of simply going long the stock. Even if F surprises us and pulls back instead of charging forward, we get to keep the 35 cent premium we collected by selling the call option, regardless of what happens. And if our F shares aren’t called away at October options expiration, no problem — we’ll simply keep writing calls against the shares until it is called away to generate income.
Now is the perfect time to join my breakthrough income investing service, Cash Machine Trader, and discover how selling covered-call options can help you manufacture ‘top-up dividends’ of up to 30% per year.
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