Does a company that can possibly generate $11 billion in free cash flow in 2012 sound enticing to you? Maybe it does and maybe it doesn’t, but one cannot argue there could be a lot of money left over at Intel (NASDAQ:INTC) for dividend payouts and stock buybacks. Against this fundamental backdrop, INTC is a compelling covered-call candidate.
Here’s why.
Intel is the world’s largest manufacturer of transistors, and demand for PCs is thriving globally, especially in China and Brazil. INTC has fallen behind in the chip game for smartphones and tablets but continues to thrive in the mobile computing area (such as cloud-computing servers). Barclays expects sales in that area to increase 7% this year. The current dividend payout-ratio is about 35% but is expected to rise.
Technically speaking, the stock has been in a decent uptrend, moving form $20 to about $27 in the last six months. Over the last two months, the stock has been hanging out in the $27 area even throughout these last few weeks of turbulent broader-market action.
If the stock can survive this potential pullback that seems to be hanging over the market, it might be able to move (slowly) higher off of its bullish base from here.
The Trading Idea
Buy 100 shares of INTC at $26.91 (Wednesday’s closing price) and sell the April 28-strike call for a credit of 38 cents or better. The debit for buying the stock is $2,691 and the premium received for shorting the call is $38, for a net debit of $2,653.
The maximum profit, if INTC finishes at or above $28 at April expiration, is $147. The covered-call trader will make $109 in the stock (on a move from $26.91 to $28) and keep the credit of $38 from selling the upside call. Breakeven for this trade is $26.53, or the stock price at the time the trade was initiated less the premium collected.
The maximum loss is $2,653 in the unlikely event that Intel plunges to zero ahead of April expiration (and traders decide to stay in the trade for the entire journey south). There is also the surrender of potential upside if INTC rallies sharply, as the shares will likely be called away at the 28 price point.
Trade Management
The best-case scenario for a covered call strategy is for the underlying stock to rise just high enough that it reaches the sold call strike at expiration. The stock then moves up the maximum amount without being called away, gains are enjoyed on the shares, and the sold call expires worthless. In this trade, that strike price is $28, or 4% above current levels.
In the event INTC moves past the $28 area and it looks like it will go much higher, then the call that was previously sold (April 28) can be bought back and a higher strike can be sold against the position to avoid assignment. (This is sometimes called “rolling” the position). This move allows the trader to keep INTC in his portfolio and it also gives the trade a chance to increase its overall return. The way INTC has been performing lately, the stock moving much past $28 by April 20 seems highly unlikely.
If the stock drops in price more than was anticipated, it might make sense to close the entire trade (stock and short call) to avoid potential further losses.
As of this writing, John does not own Intel shares or options.
