These days, it seems like options traders have to be even more alert to external conditions than usual. Between earnings season and the European debt crisis and banking situation, you really have to weigh all the technicals and fundamentals of a stock before taking the plunge into a new position.
It can feel like walking through a minefield at times. You can’t expect to be able to control the European situation but, as an options trader, you can trade a stock whose company has already given a favorable earnings report. Today, I have a stock that might just fit the bill — one that looks like it won’t get easily derailed from reaching its profit goal.
Kansas City Southern (NYSE:KSU), through its subsidiaries, engages primarily in the freight rail transportation business, and business has been good. Just last week, the company hit a new 52-week high after earnings were announced. The company’s third-quarter revenue grew 24%, and its projected outlook is quite positive.
KSU has moved up quite aggressively since the beginning of October. The current market condition might take some of that aggressiveness out of the stock, at least for a few weeks. Implementing a covered call strategy here — which would consist of buying the stock and, at the same time, selling the KSU Nov 65 Call against your long shares — makes sense because $65 (its recent 52-week high) is a nice target area for the stock.
Making the KSU Covered Call Trade
With KSU currently trading at $62.21, you could …
Example: Buy 100 shares of KSU @ $62.21 and sell the KSU Nov 65 Call @ $1.10
Cost of the stock: 100 X $62.21 = $6,221 debit
Premium received: 100 X $1.10 = $110 credit
Maximum profit: $389 — that’s $279 ($65 strike and target price – $62.21 market price X 100) from the stock and $110 from the premium received if KSU finishes at or above $65 @ November expiration.
Breakeven: If KSU finishes at $61.11 ($62.21 – 1.10) @ November expiration.
Maximum loss: $6,111, which occurs in the unlikely event that KSU goes to $0 @ November expiration.
Managing the KSU Covered Call Trade
The main objective for the covered call strategy is for the stock to just rise up to the sold call’s strike price, which in this case is $65. 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 for whatever reason, it might make sense to close out the entire trade (both the stock and the short call) to avoid further losses.
It is always good to have a trading plan in place before the trade is executed.
Options trading mastery is the flower that blooms after the long, successful journey of growth has been made.