Option Plays That Offer Large Premiums

by Lawrence Meyers | July 20, 2012 10:00 am

Options are useful for many different reasons, but today I’ll focus on options that may offer either large upside or large premiums, for those seeking the home-run play. Of course, with large reward comes large risk, so bear this in mind.

I think I have a perpetual covered-call play in Wynn Resorts (NASDAQ:WYNN[1]). As I wrote the other day[2], Wynn isn’t going anywhere. The company generates great cash flow, it’s a fabulous operation with world-class management, and likely will pay off for any long-term investor. However, I also made the point that swing trading the stock might offer more definitive ways to capture capital gains.

With respect to options, because Wynn is solid financially, it makes it a candidate for a particular strategy: buy the underlying stock and repeatedly sell covered calls against it. It’s a high-priced stock that tends to be volatile, so that sets it up for generous premiums.

As I write, the stock is at $99.66. The August 100 calls are going for $3.25. That’s a 3.69% return, or about 42% annualized. If you sell the calls and the stock gets called away, I suggest you just repurchase the underlying and sell calls the next month out. If it isn’t called away, sell calls for the next month anyway. You’ll also collect the 2% dividend along the way.

There is a risk that Wynn will face economic headwinds in the short to medium term and the stock could fall further. To my mind, that’s just a chance to average down while collecting cash along the way.

I knocked it out of the park when Green Mountain Coffee Roasters (NASDAQ:GMCR[3]) reported last quarter, having purchased puts for a mere $2 the day before earnings, and selling them for $17 after the company imploded. Could it happen again on Aug. 1, its next reporting date?

The stock is now at $17.74, so I don’t think we’ll see a $17 drop — even on poor earnings. That being said, there might well be six or seven points to the downside available, and even more to the upside if the company surprises. I would purchase both an at-the-money put and call on July 31. They’ll probably set you back something like $1.50-$1.75 per contract. It’s certainly possible the stock won’t move after the report, but Green Mountain is in a tenuous position these days. I expect a large move.

Finally, Coinstar (NASDAQ:CSTR[4]) has been volatile lately. It ran up some 12-13 points after its earnings report and Starbucks (NASDAQ:SBUX[5]) partnership, then gave most of it back, as analysts needlessly began hand-wringing over other developments. They fail to see the big picture with Coinstar, but that just gives us opportunity.

The stock is at $61 right now, so for heaven’s sake, sell the August 62.50 calls for $3.20. That’s a whopping 7.5% return. Or sell the October 65 calls for $3.70, for a 13% return. If the stock gets called away, that’s unfortunate, which is why I suggest going long and selling against only half of your position. If the stock drops from here, congratulations on effectively averaging down on an already undervalued stock.

As of this writing, Lawrence Meyers held shares of CSTR and intended to purchase both puts and calls on GMCR prior to earnings.

  1. WYNN: http://studio-5.financialcontent.com/investplace/quote?Symbol=WYNN
  2. wrote the other day: https://investorplace.com/2012/07/wynn-earnings-dont-tell-the-whole-story/
  3. GMCR: http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR
  4. CSTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=CSTR
  5. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX

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