Cover Up With This Cold-Weather Call

by John Kmiecik | October 25, 2012 8:50 am

Fun in the sun looks to be turning into snow shoveling time as winter-like weather starts to approach many areas of the United States — but that does mean snow can’t be fun, too.

Here is a trade idea on a company that counts on people having some fun in the snow, and could generate some profits for traders and investors:

Polaris Industries (NYSE:PII[1]) manufactures all-terrain recreational and utility vehicles and snowmobiles. Over the last year, there has been an increase in off-road vehicle demand, which has helped the company’s earnings. The company announced third-quarter revenue last week and beat expectations on revenues and earnings per share. Sales for the quarter were up more than 20% from the prior-year’s quarter, and next year’s average estimate for revenue is $3.16 billion.

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Taking a look at the chart, Polaris stock has been ebbing and flowing higher since the beginning of July and recently hit its all-time high. With the market selling off recently, PII has pulled back some and has given investors a little lower price to buy in. The 90 strike was chosen to sell because that was just above the stock’s all-time high.


Example: Buy 100 shares of PII @ $83.59 and sell the November 90 call @ 50 cents.
Cost of the stock: 100 X 83.59 = $8,359 debit.
Premium received: 100 X 0.50 = $50 credit.
Maximum profit: $691 — that’s $641 (90 – 83.59 X 100) from the stock and $50 from the premium received if PII finishes at or above $90 @ November expiration.
Breakeven: If PII finishes at $83.09 (83.59 – 0.50) @ November expiration.
Maximum loss: $8,309, which occurs in the unlikely event that PII goes to $0 @ November expiration.

Trade Management

The best-case scenario for this covered call strategy is for the stock to just rise up to the sold call’s strike price at November expiration, which in this case is $90. The stock moves up the maximum amount without being called away, and gains are enjoyed on the shares and the option premium. Then the process can be duplicated for the next expiration if so desired.

If PII makes a move past its all-time high and past the $90 strike well before November expiration, the call option can be bought back and a higher strike can be sold against the position to avoid assignment. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return especially if stock moves higher.

The breakeven point of the trade is situated just above an upward trendline that connects the previous three pivot lows. This could act as a strong area of support and possibly keep the stock from moving lower.

If support doesn’t hold and 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.

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

  1. PII:

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