We originally bought shares of Bank of America (NYSE:BAC) for $25 each, and since we bought those shares, we’ve sold two covered calls with strike prices at $25.
Last Friday we thought we’d be saying goodbye to our shares because BAC was trading above $25 most of the day and our last covered call was set to expire.
But by the time the closing bell rang on Friday afternoon, BAC had slipped down to close at $24.98 — two cents below our strike price. This meant our calls expired out of the money, the calls were not automatically exercised, we got to keep 100% of the premium we received when entering the trade and we got to keep our shares of BAC.
So, what do you do when you get a pleasant surprise like that handed to you?
You sell another covered call against the stock, of course. If you, like us, are holding shares of BAC, this is a trade to earn you extra income while the stock recovers.
Businesses are Buying and Leasing More
The financial sector is in an interesting spot right now. While the sector, as represented by the Financial Select Sector SPDR Fund (NYSEARCA:XLF), is rising, it is also lagging the rest of the market.
While the S&P 500 has set new highs, XLF is contending with resistance at its 200-day moving average.
Daily Chart of the Financial Select Sector SPDR Fund (XLF) — Chart Source: TradingView
At the same time, there have been positive developments. According to Reuters, the Equipment Leasing and Finance Association’s (ELFA) leasing and finance index showed improvement in U.S. companies’ borrowing was only down 3% year-over-year in July. That means we’re seeing more spending from businesses than in June.
Being “down by less” isn’t exactly the best news for financial stocks like BAC, but that didn’t stop the stock from rising yesterday.
And it’s always important to remember that with a covered call, we don’t necessarily need (or want) the stock’s price to explode.
Could $25 Act as Support?
As we mentioned, BAC rose slightly yesterday, pushing above the $25 level that acted as resistance in April and July. Now we expect it to act as support, which means traders may want to sell a covered call slightly above that level.
Daily Chart of Bank of America (BAC) — Chart Source: TradingView
Since we originally bought our shares of BAC for $25 each, there’s no downside to us selling a call with a strike price above that level. If the stock rises above our strike and we have our shares called away, we will get to keep all the premium from the option, plus we will be selling the stock for a higher price than we paid.
We recommend selling the at-the-money call options, which would have a strike price of around $25.50.
The at-the-money options have the largest amount of extrinsic value built into their premiums. The farther in the money or out of the money you go, the less and less extrinsic value is built into the premium.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of Strategic Trader.