Finding a decent covered-call candidate in this market is not easy. Generally, traders and investors try to find a stock that is trading sideways or maybe just trending up. Another key is to find a company with solid fundamentals, especially if you want to hold the stock for an extended period. Though there is no guarantee that the stock will trend higher in the future, many traders would rather hold a fundamentally sound stock than one with shaky financials.
A covered call is generally used to generate additional income for a stock position. The strategy is to buy stock (or already own it) and sell a call option against it. A good thing about a covered call is that it can profit even if the stock trades sideways, because if the short call expires worthless, the premium is yours to keep, which helps offsets the cost of the stock. Let’s see what looks good this week.
Buffalo Wild Wings (NASDAQ:BWLD) has pretty decent fundamentals. The stock has been trading in a range between $58 and $64 for about the last month. With support at $58 and resistance at $64, the October 65 call looks like the option to sell. This trade gives the stock some upside potential to go higher, and the break-even point on the trade will be somewhat close to the technical support.
The Trade: Buy 100 shares of BWLD at $61.50 and sell October 65 call at $2.20
Cost of the stock: 100 x $61.50 = $6,150 debit
Premium received: 100 x $2.20 = $220 credit
Maximum profit: $570 — that’s $350 ($65 – $61.50 x 100) from the stock and $220 from the premium received if BWLD finishes at or above $65 at October expiration.
Break-even: If BWLD finishes at $59.30 ($61.50 – $2.20) at October expiration.
Maximum loss: $5,930, if BWLD goes to $0 at expiration.
The main objective with a covered call is for the stock to rise up to the sold call’s strike price — in this case, $65. The stock moves up the maximum amount with being called away and the sold call expires worthless.
If the stock moves past $65 and looks like it’s not going to slow down, then the call that was previously sold (October 65) can be bought back and a higher strike 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.
Remember: No matter how far the stock goes beyond $65 at expiration, the maximum profit is capped because of the call that was sold at the 65 strike.
If BWLD plummets, the stock can be sold, and the short option can be bought back to try and reduce losses. The company is scheduled to announce earnings on Oct. 24.
Every trade should have defined risk and loss parameters in place even if the trader or investor is just “paper trading.”
