Buy-Write Your Ticket on the UNP Profit Train

by John Kmiecik | February 1, 2012 8:05 am

Where did January go? It’s gone already, and you might need to assess whether your trades and investments are on track for 2012. If not, maybe you need to look for more stable or solid investments to round out your account. Here is a trade idea that might prove to be just the ticket to board the profit train to your desired destination.

Union Pacific Corp. (NYSE:UNP[1]) is the largest American railroad. It recently reported earnings and, by most standards, did not disappoint. Fourth-quarter profit came in at $964 million, which was up almost 25% from last year.

UNP has been in a nice uptrend since the end of November 2011. The stock has slowly set higher highs and higher lows, which is considered a bullish trend. Most analysts have a great opinion of the company and stock, with several rating it a “Strong Buy.”

UNP has been trading at the top of its bullish range, so it may pull in some before it tries to go higher again. Lately the stock has continually set all-time highs, and it should be able to keep chugging along even higher – making this an ideal setup to do a buy-write, or covered-call, trade.

Making the UNP Covered Call Trade

With UNP trading here at $114.31, you could…

Example: Buy 100 shares of UNP @ $114.31 and sell the UNP Feb 115 Call @ $1.85

Cost of the stock: 100 X $114.31 = $11,431 debit

Premium received: 100 X $1.85 = $185 credit

Maximum profit: $254 — that’s $69 ($115 – $114.31 X 100) from the stock and $185 from the premium received if UNP finishes at or above $115 @ February expiration.

Breakeven: If UNP finishes at $112.46 ($114.31 – $1.85) @ February expiration.

Maximum loss: $11,246, which occurs in the unlikely event that UNP goes to $0 @ February expiration.

Managing the UNP Covered Call Trade

As in most cases, the main objective for a covered call strategy is for the stock to just rise up to the sold call’s strike price at expiration, which in this case is $115. The stock moves up the maximum amount without being called away, gains are enjoyed on the shares and the sold call expires worthless.

In the event UNP surges past the $115 area, which is the strike that was sold, and it looks like it will go much higher, then the call that was previously sold (the Feb 115 Call) can be bought back and a higher strike can be sold against the position to avoid assignment. This allows the stock to remain in the portfolio and also give the position a chance to increase its return.

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.

  1. UNP:

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