I know there are a lot of investors out there that are in love with their momentum stocks, and they either don’t care about or poorly assess risk. You folks buy the momentum names and sit tight. I suppose there is some merit to this approach if you have a very high-risk tolerance.
Since I imagine some readers own these stocks, I have to be responsible and suggest that they are way overvalued, and we are in the midst of a Big Tech correction, so now is the time to consider hedging the downside with covered calls.
With covered calls, you have the opportunity to sell the right for another investor to buy your stock at a given price on or before a given date. You earn a premium for selling this right. If you use a high-priced growth or momentum stock with covered calls, and you sell that right several months out, you can make a sizable premium.
That premium can serve as either as immediate additional income or as a downside hedge. My stock advisory newsletter, The Liberty Portfolio, uses covered calls, but does not get into these momentum stocks because of the risk. The Liberty Portfolio prefers to deal with lower-risk securities that offer opportunities for additional monthly income.
Hedge the Big Tech Correction: Alphabet (GOOGL)
Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) is both a growth stock and a momentum stock. GOOGL stock has strong fundamentals, and backing out cash, is trading at a fair multiple, considering its growth.
Still, Alphabet is facing downward momentum in this market, and may soon face privacy issues. Remember, it isn’t government regulation that is the problem, it is the threat that its model may be undermined by public outcry and advertisers running for the hills.
GOOGL stock trades at $1,009 and has $180 per share in net cash, meaning it effectively is worth $829 per share.
So, if you sold the 15 June $1,100 covered calls, you would collect $24 per contract, or $2,400 in cash. Not only do you get this 2.37% for a three-month holding period, but you hedge your downside by 24 points and the stock still wouldn’t get called away from you until it rises back up $100 per share.
Hedge the Big Tech Correction: Netflix (NFLX)
I’m sure many investors own Netflix, Inc. (NASDAQ:NFLX). I have long said that Netflix is just nuts in terms of valuation, and is burning cash at a rate of well over $1 billion per year. Sure, it has a profit, but don’t tell me that NFLX is worth $124 billion.
I know there are doubters out there who think I am missing out on this fantastic investment. It’s just not for me. There is too much risk. We are seeing some of that risk playing out right now. NFLX stock has fallen from $338 per share to $286 per share in a very short period of time. This is the problem with momentum stocks. You can get wiped out very quickly.
Still, if you insist on holding the stock want to book a little upside but protect some downside, the 15 June $300 covered calls have a very nice premium of $21 per contract. You pick up $2,100 per contract, which is a 7.5% return for that 3-month holding period. You also get $21 of downside protection from here.
Hedge the Big Tech Correction: Chipotle (CMG)
Chipotle Mexican Grill, Inc. (NYSE:CMG) has still managed to hold up at $320 per share, despite a business that has been slowly but surely deteriorating. As it is, the stock is hundred and $80 off its 52-week high, or about 36%. it is also about 55% off of its all-time high.
That being said 2017’s total revenue was close to what it was in 2015. The problem was gross profit fell by 40%. By the time we got to the bottom line, CMG net income was $176 million, a far cry from the $475 million of 2015.
I do not see how anyone can justify paying 55 times net income for a restaurant chain that is in serious trouble.
However, there are those above you who still insist on holding onto the stock. In this case, you may want to consider selling some covered calls. The 15 June $335 covered calls are selling for $18. That means you would collect $1,800 right now, and give you a 5.3% downside hedge. That translates to a 5.3% return for a three-month holding period.
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.
