This market has been tough to navigate, to say the least. After all, it’s not easy to watch your stocks gain 5% one day and give back 6% the next. It’s even more challenging for options traders, who may get stopped out of a promising trade at a 30% or 50% loss, only to see those options recover later that same day … which would have been great if only they were still in their positions!
As options traders, we typically benefit from volatility. But although there are nice returns to be made during periods of uncertainty, many option strategies are not suitable or just don’t make sense in choppy markets like we’re experiencing now.
However, if you’re seeking some safety, and/or looking to make some income from the stocks you own or want to own, there’s one option strategy that makes perfect sense in any market: the covered call.
A covered call is when you buy, or already own, stock and at the same time sell call options against your long shares. It’s like collecting a reward for holding shares long; selling calls against your stocks puts money in your pocket instantly and can be done every week (or month, if your stock offers weekly options).
Another benefit of a covered call is that it is like purchasing the stock at a discount rate. The credit received from the short call offsets the purchase price of the shares of stock. In essence, the short call lowers the breakeven point on the trade. This is especially beneficial if the stock drops in price, which is prone to happen in an up-and-down market.
Today our OptionsZone experts have five powerful covered call trades that you can make right away. Let’s take a look at them now.
Trade #1 — Visa
Recommended by John Kmiecik, MarketTaker.com
Visa Inc. (NYSE:V) looks like very viable covered-call candidate right now. Many of us are quite aware that the company provides payment solutions for the credit and debit programs of financial institutions. The company is currently very sound fundamentally, which is good if you own, or want to own, the shares.
The stock has recently broken out of a downtrend and is now trading above the daily 8-, 20- and 200-day moving averages, which can be construed as a bullish sign.
Visa has some support at the $88 level, which it is trading just above right now. The stock should have some trouble falling and staying below that level as long as the market does not become extremely bearish.
The stock has resistance in the $93 area, which makes for a legitimate short-term target. The company is expected to announce earnings on Oct. 26. In this case, choosing an option with October expiration date is a good strategy, because the options will expire before the earnings date and you’ll be able to avoid the uncertainty of the sometimes-volatile announcement.
Here’s the setup:
Example: Buy 100 shares of V @ $90.51 and sell 1 Oct 92.50 Call @ 1.00
Cost of the stock: 100 X $90.51 = $9,051 debit
Premium received: 100 X $1.00 = $100 credit
Maximum profit: $299 — that’s $199 ($92.50 – $90.51 X 100) from the stock and $100 from the premium received if V finishes at or above $92.50 @ October expiration.
Breakeven: If V finishes at $89.51 ($90.51 – 1.00) @ October expiration.
Maximum loss: $8,951, which occurs in the unlikely event that V goes to $0 @ October expiration.
The main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price, which in this case is $92.50. The stock moves up the maximum amount without being called away and the sold call expires worthless.
If the stock drops in price more than was anticipated, it might make sense to close out the entire trade (stock and short call) to avoid further losses.
Be careful and trade smart!
Trade #2 — Citigroup
Recommended by: Chris Johnson & John Lewis, Editors, The Winning Edge
Citigroup (NYSE:C) has been a beleaguered stock. It’s down around 40% for the year and 46% from its January high. Just for perspective, the stock is down around 95% from its all-time high.
While low can always get lower, C’s chart has been looking up of late. The shares appear to have found a base around the $25 level, and the stock is up a whopping 30% from the multiyear low it reached just last week.
Currently, the stock is trading at the $29 level, as it duels with its overhead 50-day moving average. A break above this trendline leaves plenty of upside room to run.
At the current stock price, you can sell an Oct 30 Call for 90 cents. If the stock breaks above the 50-day and you get exercised, you’ll sell at $30 and keep the option premium. That nets a return of more than 6% in less than two weeks.
If the shares decline, you’ve bought around 2.8% of downside protection. And the 20-day moving average sits underneath, ready to lend support if the stock weakens.
Trade #3 — Tiffany & Co.
Recommended by: Michael Shulman, Options Income Blue Print
If you can handle serious volatility — for months and years, not just weeks — look at buying Tiffany & Co. (NYSE:TIF) stock and immediately writing some calls.
Three years ago, I posited a new theory of consumer spending — the “New Frugal” — and wrote that even during a downturn, high-priced products that were high-quality and supported by great brands would continue to do well despite the recession. This has panned out with companies and stocks such as Apple, Coach, Ralph Lauren, Nordstrom and Tiffany. And TIF is climbing back again toward an all-time high.
Their products are the gifts one does not forego giving. You may trade down from diamond earrings to a tennis bracelet, or from a pewter piece of Elsa Peretti to something 20% percent less expensive. But it is that little robin’s-egg-blue box that gets people coming back. And Tiffany has the complete product line to enable the New Frugal shopper.
Don’t believe me? “Diamonds are Forever” and all the mythology about the diamond engagement ring was born during the Great Depression.
Tiffany’s earnings come out Nov. 29, giving you a couple of short-term strikes to sell against. Option premiums are wonderfully outrageous. If you buy the stock now around $70, you can write a Nov $72.50 Call for $3.50 or more.
If you get called out, you make six bucks in five weeks, a return of 8.5%. Annualize that and you have a return of roughly 85%.
Or if you sell the Jan $75 Calls, you can collect at least $5.20. And if you get called out, you pocket more than $10 a share, a 15% return in less than three months.
The risks? The stock could goes down. But if that happens, you buy back your short call and, when the time is right, you sell it again — generating cash to spend and averaging down your position, on paper. And with that cash, you can go shopping you-know-where!
Trade #4 — Altria
Recommended by: Tyler Craig, Tyler’s Trading
When it comes to covered call selection, two popular schools of thought exist.
The conservative approach consists of buying the shares of stable dividend-payers and selling monthly covered calls to boost returns.
The aggressive approach consists of identifying faster-moving stocks that boast options with high implied volatility. The elevated option premiums offer more-alluring returns, offsetting the additional risk of these somewhat-unstable stocks.
One covered call candidate worthy of consideration for those desiring to take the more-conservative route is Altria Group (NYSE:MO).
With an annual dividend of $1.64, the tobacco giant is currently yielding 5.9%. The relative inexpensiveness of the share price ($27.50) also makes the purchase of 100 shares of stock a realistic endeavor for those with smaller accounts.
Of the November call options available, the $28 strike offered at 60 cents provides the best return for those with a mildly bullish outlook on MO.
At the time of this writing, Tyler Craig had no positions on MO.
Trade #5 — DSW Inc.
Recommended by John Kmiecik, MarketTaker.com
The market has been uncertain, but one thing that is certain is that a lot of women love shoes, and shoes at a discount. DSW Inc. (NYSE:DSW) looks like a good choice for shoes and a great choice for a covered call this week.
The company operates over 300 shoe stores, and plans on opening at least another 10 by the end of the year. The company’s sales have grown in double digits for eight straight quarters.
The theory on this covered call trade example is this:
DSW has traded between about $43 and $49 for the better part of a month. Just on Monday, the stock broke out of that area to the upside, which is a bullish sign. The stock may come down and retest the $49 area before making its way higher.
With just under two weeks left until October expiration, selling the Nov 55 Calls provides a greater premium than the Oct 55 Calls because more time is priced into the option. A longer expiration will give the stock extra time to reach the $55 area as well.
Here’s the setup:
Example: Buy 100 shares of DSW @ $50.39 and sell 1 Nov 55 Call @ $1.50
Cost of the stock: 100 X $50.39 = $5,039 debit
Premium received: 100 X 1.50 = $150 credit
Maximum profit: $611 — that’s $461 ($55 – $50.39 X 100) from the stock and $150 from the premium received if DSW finishes at or above $55 @ November expiration.
Breakeven: If DSW finishes at $48.89 ($50.39 – 1.50) @ November expiration.
Maximum loss: $4,889, which occurs in the unlikely event that DSW goes to $0 @ November expiration.
The main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price, which in this case is $55. The stock moves up the maximum amount without being called away, gains are enjoyed on the shares and the sold call expires worthless.
If the stock moves past $55 and looks like it’s going to go much higher, then the call that was previously sold (Nov 55 Call) 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.
The breakeven point ($48.89) of this covered call is by a nice area of support in the $48 – $49 area.
If the stock drops in price more than anticipated, it might make sense to close out the entire trade (both the stock and the short call) to avoid further losses.
The company is expected to announce earnings on Nov. 21, just a few days after November options expiration.