Is the market looking frothy to you? You may have your own personal outlook, but all traders and investors should take note that the Dow is having trouble maintaining a perch above the 13,000-point level. The broader market may continue higher or it may sell-off a bit as it struggles with this round number.
No matter what the broader-market backdrop might look like, a smart investor needs to be able to find stocks that have solid fundamentals and also looks good from a technical perspective. Here is an options trading idea for a good-looking covered call candidate.
Chicago Bridge and Iron Company (NYSE:CBI) is one of the world’s leading engineering, procurement and construction companies and a major process technology licensor that employs 18,000 people worldwide. The company recently announced earnings per share that topped analysts’ estimates, while revenue was in line with Street expectations. The company has excellent fundamentals and most firms have rated the stock an outperform (13 of 15 analysts have named the stock a “strong buy” or “buy”).
The rationale driving covered call trade is this:
CBI has been in a slow and steady uptrend since the beginning of October last year, setting higher pivot highs and higher pivot lows. A slightly bullish and dependable stock such as CBI can be very advantageous for the covered call seller. The next technical resistance this stock may encounter (which might keep the stock from temporarily going higher) is the $50 area. Selling an out-of-the-money April 48 strike will allow the stock to pull back some and still give the stock some room to head higher just below resistance.
The trade: Buy 100 shares of CBI at $46.52 or less and simultaneously sell the April 48 call for a net credit of $1.35 or better. The stock position will cost $4,652 (100 times $46.62). This will be offset by the $135 credit collected for selling the calls, so the total capital invested is $4,517.
The maximum potential profit from the covered call trade is $283 if the stock finishes at or above the 48 strike at April expiration. $135 of this profit is from selling the call; $148 is from gains in the stock between the 48 strike and its current price of $46.52. Gains can ultimately be more in the shares, of course, if the shares are not called away after the call expires.
Losses are maximized at $4,517, which occurs in the unlikely event that CBI plunges to $0 before April expiration (and the covered-call trader rides it the entire way down). Breakeven for the position is $45.17. If CBI is trading above this level when the call expires, the trade will be profitable.
Trade Management
As in most cases, the main objective for a covered-call strategy is for the stock to rise up just to the sold call’s strike price at expiration, which in this case is $48. The stock moves up the maximum amount without being called away (i.e., the sold call expires worthless, allowing the seller to keep the full credit) and a profit is realized on the shares.
In the event CBI rallies through the 48 strike (and looks like it will go much higher), then the call that was previously sold (April 48) can be bought to close and a higher strike can be sold against the position to avoid assignment. This strategy allows the stock to remain in the account and also gives the position a chance to increase its return.
If the stock drops in price more than anticipated (based on a previously established stop loss), it might make sense to close the entire trade (stock and short call) to avoid further losses.
Remember to have a plan in place before entering any trade!
As of this writing, John Kmiecik does not own any shares mentioned here.
