Is the economy really growing? The economic reports released lately have given mixed signals. Many stocks have decreased in value in April after bullish runs to start the beginning of the year.
But there are a few sectors of stocks that continue to exemplify growth not only in their share prices but also but also throughout their industry. Lowes Companies Inc. (NYSE:LOW) is one example that looks like an attractive covered call candidate.
LOW is a giant in the building material, garden equipment and supplies retail segment. The latest retail trade data showed that sales were higher by 3% in that industry. Whether it was the warm weather this spring or just consumers fixing up their houses on their own and trying to save some money cannot be completely determined. What’s more, Lowe’s is consistently ranked among America’s most-admired and successful companies by leading publications and organizations.
Technically, the stock has been moving higher since October 2011. Even with this recent bearish move by the market, the stock was able to hold its own and reestablish its upward momentum. The stock has some resistance right around $33 (its previous five-year high) that might keep it from immediately going higher. If it can clear that hurdle, LOW might just keep building profits in your portfolio.
The Trade Idea – Covered Call
Buy 100 shares of LOW for $31.96 and simultaneously sell to open one May 33 call for a credit of 34 cents each. The stock will cost a total of $3,196 but be offset by the $34 credit, making the total cost of the position $3,162.
The maximum profit from this trade is $138, or the $104 difference between the current stock price and the sold strike price, plus the credit obtained from selling the call. Maximum profit is achieved if LOW finishes at or above $33 when May options expire.
Breakeven for this trade is $31.62. If LOW is trading above this level at May expiration, the covered call strategy will be profitable. The maximum loss is $3,162, which would occur in the unlikely event that LOW falls all the way to zero in the next month ahead of May expiration.
Trade Management
The goal for a covered call strategy is for the stock to rise up to the sold call’s strike price at expiration, which in this case is $33. The stock moves up the maximum amount without being called away, gains are collected on the shares and the sold call expires worthless.
In the unlikely event LOW breaks its pattern of slowly rising and begins to rally strongly, there is a strategy a trader or investor can implement. If the new outlook for the stock is much higher than $31, the call option 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 gives 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 possibly avoid further losses.
LOW is expected to announce earnings on May 21, which is right after May expiration.
As of this writing, John Kmiecik does not own any shares mentioned here.
