In my last options article, I talked about selling naked puts on expensive stocks as a way to either collect big premiums or have expensive stocks put to you at a lower price.
Today, I’m going to reverse this strategy by talking about selling covered calls on similar (or the same) momentum stocks.
There’s a slight difference here, though, even if we’re talking about the same stocks.
When it comes to naked puts, you have to address the trade as if you’d actually want to own those stocks. But with covered calls, sure, if the stock gets called away, you’re happy to collect the premium … but if it doesn’t get called away, you’re stuck with it (unless you decide to sell more covered calls).
So while you can earn a good premium for these momentum stocks, remember that you might end up owning them — and that momo stocks can get clobbered in a hurry if things change.
Covered Calls on Netflix (NFLX)
Netflix (NFLX) is probably the most insane of the momentum stocks right now. I love Netflix’s service, and the company’s original programming is terrific.
However, I cannot justify the current NFLX stock price in any way, even if I was as insane as Ultron.
Still, there’s an opportunity to sell covered calls here, as well as a decent chance in that it either gets called away or at least doesn’t drop that much before expiration.
NFLX stock trades around $620. I wouldn’t sell the monthly covered calls because that comes too close to Netflix earnings, and NFLX stock might gyrate around that time. Instead, sell the Jul 10 weekly $620 covered calls for $22.
First, you pick up $2,200 in premium for the sale. If the stock stays above the $620 level and it gets called away, great! If not, then your breakeven on NFLX stock is $600. I suspect that’s a relatively safe level, such that if your shares aren’t called away, you’ll be able to either sell out altogether without a huge loss, or you can take a risk and sell more covered calls.
Covered Calls on Tesla Motors (TSLA)
Where would momentum stocks be without Tesla Motors (TSLA)?
Hey, Elon Musk is a genius and a pioneer. I really hope his cars take off. I hear they are amazing machines.
Alas, TSLA stock cannot possibly justify its valuation, either. Tesla lost roughly $300 million last year, cash flow was negative, and the balance sheet has more debt than cash.
The stock trades at $248, valuing the company at $31 billion. That’s insane, but hey — TSLA is a trading stock. So if you are going to use covered calls, give yourself a little breathing room and sell the monthly Jul $245 calls for roughly $13.
If your shares get called away, you’ll sustain $300 in capital losses but net out roughly $1,000, or about 4%. That’s pretty darn good. And if not, you’ll also give yourself a bit of a hedge, as you’ll effectively own TSLA stock at $235.
Covered Calls on LinkedIn (LNKD)
Then we have LinkedIn (LNKD), which at least has real earnings and cash flow to speak of, although not enough to justify trading at 65 times next year’s earnings.
Tell me how a company expected to earn about $210 million this year is trading at a $27 billion market cap.
The thing about LNKD stock, though, is that there’s probably a pretty high floor to the stock price because some idiot is going to buy the company at some point. Unlike NFLX and TSLA, though, I don’t think LinkedIn offers anything of value.
Nevertheless, we have a $216 stock, and you can earn a generous premium by selling the monthly Jul $210 calls for $11.25. That gives you $6 of hedge built in since you’re selling an in-the-money call. However, like the other momentum stocks, I would not hold this stock heading into earnings (which are expected to come in July 29). That’s where the biggest risk is, so either you win or lose on this trade, then get out.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
