With the S&P trading at or very near to the upper end of the long-term channel uptrend, it gives traders seeking options income an appealing environment for executing covered calls at attractive premiums.
And while I continue to hold and recommend a stable of high-yielding, long-term assets in both my Cash Machine and Extreme Income portfolios, for those looking to also round out their strategy and capture some short-term gains on the best-of-breed blue chips, covered calls that offer a measure of protection along with the potential to profit remain an ideal tactic in the midst of some near-term concerns.
The two areas causing the markets apprehension this week are outside of the United States. The first is that Asian stocks retreated from a six-week high Monday, and as a result China’s CSI 300 Index dropped to a five-year low after news dropped over the weekend showed that exports from China fell 18.1% in February from the prior year. That was the largest decline since August 2009 – and the median estimate among Bloomberg analysts had called for a 7.5% increase. The data took the wind out of the recent upbeat tone for the materials sector amid comments that March data will show a rebound.
The second concern is Russian forces’ advance in Ukraine’s Crimean peninsula, ignoring Western calls to halt a military takeover before the region’s separatist referendum. The United States estimates that Russia now has 20,000 troops confronting a smaller Ukrainian force there.
How much of this Russian occupation of Ukraine will hit Wall Street’s shores is speculation, but as per the American Association of Individual Investors (AAII) survey, it’s not something that U.S. consumers are losing sleep over.
The more the world is at unrest, the greater the rotation into U.S. markets as a place to find safer investments in the world’s largest economy. It’s an economy that is progressing at a pace that can grow revenues, profits and even jobs, albeit at slower pace. But sequential growth fostered by a dovish Fed remains the best investing proposition for risk capital, and I don’t see that profile changing up much any time soon.
So, continue holding and building positions in the kinds of quality names I recommend, while also incorporating short-term covered calls as a way to safely get exposure to stocks on the run. It’s a conservative strategy delivers 6%-10% on every stock we trade in about a month’s time – and, in fact, today’s trade should bank the gain in less than two weeks.
Methode Electronics (MEI) develops and manufactures market devices that feature electrical, electronic, wireless, safety radio remote control, sensor and optical technologies to convey signals through sensors, interconnections and controls.
MEI components are in the OEM markets of the automobile, computer, voice and data communication systems, information processing and networking equipment, consumer electronics, aerospace vehicles, appliances, and industrial equipment industries.
The company has blown past earnings estimates the past four quarters and should pick up speed again ahead of its earnings report in early March. The stock is trading today at $34, but timing is of the essence as the company will release earnings on March 13, at which time I expect the stock to challenge $36 or better. The best way to play this is with a short-term covered call in MEI.
Recommendation: For every 100 shares of MEI you own or purchase at market, sell to open one MEI Mar. $35 call at $1.65 or more, good till canceled. The call option is currently trading at $1.77 so your orders should fill immediately.
The key to using short-term covered calls is to avoid being greedy. We’re looking to capture a big part of a stock’s move up, but we’re not going to hang out on the limb waiting for every last penny. If you can pick up MEI shares around the $34 mark, by options expiration on March 21, you could rake in an easy 7.7% in about two weeks’ time. Here’s how:
When you sell to open one MEI Mar. $35 call contract at $1.65 or more, that translates to $165 hitting your account immediately. That $165 is yours to keep regardless of what the stock does. But by selling to open the $35 strike, I am making a bet that MEI shares will be trading above $35 at options expiration.
If MEI shares are above that $35 strike on March 21, on Monday, March 24, the person who bought our call contract will “call away” our shares at the agreed-upon sale price (the strike price) of $35 per share. But remember that we collected $1.65 upfront, so our exit price is effectively $36.65 (the $35 strike plus $1.65).
If our entry was $34, and our exit was $36.65, our net return on this two-week trade is 7.7%.
And I want to underscore that even if MEI isn’t trading above $35 at options expiration, you still get to keep the $1.65 you collected. You’ll also keep shares of MEI and you can (and should!) write another short-term call against those shares to keep collecting premium until your shares are called away.
I’ve said that covered calls are the cure for everything that’s wrong with options trading; follow my recommendation today to see just how powerful but prudent this strategy is.
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