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Trade of the Day: Staples (SPLS)

Covered calls on SPLS could yield you over 6%


Staples (SPLS) normally would pass under my radar, since I generally focus on high-yielding stocks—those with a 5% yield or above. Yet, at a 2.9% yield, it is a steady payer that has increased its quarterly dividend at least once per year since 2010.

Though the company stumbled on Q1 earnings, I have confidence in the growth story here. The company is redoubling on online efforts and in non-core office supplies, and  the outlook for FY13 remains solid: Staples expects sales to grow in the “low single digits” compared to 2012, and expects to generate $1.30 to $1.35 EPS this year, which is in line with analyst estimates of $1.32.

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Technically, the stock shows a steady climb upward that’s quite unlike the wild runup seen in many other stocks early in 2013. As opposed to a parabolic rise, SPLS tends to run up, then pull back or consolidate for a while, and run up even higher.

How to Trade Covered Calls on SPLS

For those who would like to earn additional income on SPLS, I recommend a covered call strategy. Covered calls are allowed in an IRA, so even retirement-minded investors can take advantage of this strategy.

The ideal scenario is that for every 100 shares of SPLS that you own or purchase under $16.40, sell to open one SPLS September $17 call at 50 cents or more per contract.

By selling covered calls, you have the obligation to deliver 100 shares of SPLS to a buyer who will purchase them at the $17 strike price should they exercise the call. If this happens, your potential gain is 6.9%, based on a $16.40 share purchase. In either case, you keep the initial $50 from every contract sold, which translates into a 50-cent credit to your per-share price for a cost basis of $15.90. If your shares are called away at $17.00, there’s your 6.9% profit.

Covered Call Trades for Synthetic Dividends

I’d like make clear that in this particular type of trade, the goal is not to necessarily hold the stock long-term but rather to buy the shares and have them get called away while we make a quick profit. I prefer to holder higher-yield names for my long-term portfolio, so SPLS’ 2.9% yield is OK, but that’s why manufacturing additional “dividends,” if you will, with covered call premium is such an attractive strategy for this stock.

SPLS looks ready for a nice move up in the near-term, and because I think it’s going to trade above that $17 strike price by September options expiration, we can use the move to profit quickly by getting our shares called away.

Now, if that doesn’t happen and we do end up holding the stock, I’m fine with it because my outlook is bullish for SPLS. If you do keep possession of the shares, simply continue to write covered calls against them, like the one I’ve recommended today.

Bryan Perry is the editor of Cash Machine, a newsletter focused on high-yield income investing with a the goal of maintaining a blended total yield of 10% across two portfolios. Bryan is also the editor of Extreme Income which uses the power of historically cheap money to create a leveraged “baby hedge fund” strategy that paves the way to massive profits and 4x greater income.

Stay tuned! Bryan is currently working hard on a brand new strategy that amplifies your income potential by utilizing a conservative options strategy based on stocks you may already own.

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