If you read my column, you know I’m quite sour on momentum stocks, but I realize there are some readers who mistakenly do not care about risk. Some investors buy the momentum names and see how far they’ll go. If that works for your risk appetite, then that’s your choice.
I know some investors own these overvalued stocks, and some may be thinking — after the recent volatility — that they want to take some profits or hedge their positions. You can do that with covered calls.
Covered calls are options trades in which you sell the right for another investor to buy your stock at a given contracted price on or before a given contract expiration date. You earn a premium for selling this right. If you use a momentum stock with covered calls, and you sell covered calls several months out, you can earn a sizable premium.
That premium may serve as either a downside hedge or as immediate income. My stock advisory newsletter, The Liberty Portfolio, uses covered calls but does not sell them on momentum stocks because they carry too much risk.
The Liberty Portfolio concentrates on lower-risk stocks that offer opportunities for additional monthly income. Read on to learn more about making money selling covered calls!
Make Money Selling Covered Calls: Netflix (NFLX)
The big gorilla of momentum stocks is everyone’s favorite streaming media provider, Netflix, Inc. (NASDAQ:NFLX).
With NFLX burning cash at an unconscionable rate and not really making much money, and taking on tons of debt to finance the billions in original programming, I don’t like the financial situation of the company.
I enjoy Netflix content, but the risk is too great for my taste in regards to the stock. You must be cautious with Netflix’s stock. The market loves it now, but what happens if that big market correction hits?
Netflix stock closed at $303.67 per share as of Wednesday. The 21 Sept $315 covered calls have a very generous premium of $13150 per contract. You make $3,150 per contract, which is a 10% return, by choosing to hedge your position for these five months.
Make Money Selling Covered Calls: Alphabet (GOOGL)
Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) is more a bona fide growth stock but has some qualities of a momentum stock. GOOGL stock has a very good business, and on a net-cash basis, trades at $850 per share.
So it trades at 21x 2018 projected net income and earnings are growing at 20%. That’s a reasonable price for a growth stock. Still, there is risk, with GOOGL stock off 17% from its high.
GOOGL stock presently trades at $1025.
If you sold the 21 Sept $1050 covered calls are selling for $65 per contract. That means you’d not only get $6,500 right here and now, and enjoy a 6.4% return, but you also enjoy another $25 of upside before the stock might get called away.
Make Money Selling Covered Calls: Chipotle Mexican Grill (CMG)
A lot of investors are believers in Chipotle Mexican Grill, Inc. (NYSE:CMG). I’m not. Once the e.coli store broke, CMG has not been able to get customers back to its restaurants. What momentum investors learned from this incident, at least I hope they learned, is that there are so many choices when it comes to fast — casual restaurants that if something drives people away from a particular restaurant, it’s very difficult to win them back, even after the issue is resolved.
Nevertheless, I recognize that some investors own Chipotle stock and have faith that the company will return to its former glory. In the meantime, holders may want to consider covered calls.
CMG stock closed Wednesday at $322, which is 36% off its 52-week high and almost 55% off its all-time high. The 21 Sept $330 covered calls are selling for $27. That means you would pick up $2,700 now, and provide you with an 8.5% downside hedge.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
