It’s Time to Call Out Target

by John Kmiecik | June 28, 2012 8:39 am

Sometimes a covered call trade idea is right in front of our face, yet we don’t realize it. Take when we go shopping, for instance. Many shoppers will run out to their favorite store and not realize it might be a good investment, as well as a convenient place to purchase our items. Here is one retailer many shoppers like and several investors covet.

The theory on this covered call trade example is this:

Target (NYSE:TGT[1]) operates general merchandise stores in the United States. TGT has many impressive attributes when it comes to judging how sound the corporation is fundamentally. TGT has improved its earnings per share by 5% in its most recent quarter compared to the same quarter last year. Net operating cash flow increased by 24% from the same quarter last year as well.

During the past year, the stock has risen faster than the S&P 500 and still is showing good potential to move higher. TGT has been hanging around the $58 area for about four months now, but recently came down to a support area and looks to be trying to move higher. It might take some time, but if TGT can make its move higher to around $60, there is no telling how far this stock can climb.


Example: Buy 100 shares of TGT @ $57.56 and sell the August 60 call @ 60 cents
Cost of the stock: 100 X 57.56 = $5,756 debit
Premium received: 100 X .60 = $60 credit
Maximum profit: $304 — that’s $244 (60 – 57.56 X 100) from the stock and $60 from the premium received if TGT finishes at or above $60 @ August expiration.
Breakeven: If TGT finishes at $56.96 (57.56 – .60) @ August expiration.
Maximum loss: $5,696, which occurs in the unlikely event that TGT goes to $0 @ August expiration.

Trade Management

The best-case scenario 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 $60. The stock moves up the maximum amount without being called away, and gains are enjoyed on the shares and the option premium.

Taking into account the past four months of price action on TGT, it is unlikely that the stock will move much higher than the sold strike before August expiration. In the event it does, the call option can be bought back, and a higher strike can be sold against the position to avoid assignment. This sometimes is called “rolling up.” It will allow 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 possibly avoid further losses.

As of this writing, John Kmiecik did not hold a position in any of the aforementioned securities.

  1. TGT:

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