With market volatility still well at hand, there are advantages to using covered-call options strategies.
A covered call means buying (or already owning) a stock and selling a call against the stock position at the same time. In general, the strategy generates additional income for a stock position. Another benefit is that it’s like buying the stock at a discount rate. The credit received from the short call offsets the purchase price of the stock.
In essence, the short call lowers the break-even point on the trade. This is especially beneficial if the stock drops in price.
Cerner (NASDAQ:CERN) looks like very viable option right now. The company develops medical record and financial management software applications for healthcare providers. The company has an impressive record of earnings per share growth and revenue growth.
The stock is up over 44% for the year and just hit a new 52-week high just last week. The shares might just take a breather before it decides to continue its climb higher. Selling the November 75 call will give the trade some time and still allow for the stock to go higher.
The Trade: Buy 100 shares of CERN at $70.50 and sell November 75 call at $2.70
Cost of the stock: 100 x $70.50 = $7,050 debit
Premium received: 100 x $2.70 = $270 credit
Maximum profit: $720, that’s $450 ($75 – $70.50 x 100) from the stock and $270 from the premium received if CERN finishes at or above $75 at November expiration.
Break-even: If CERN finishes at $67.80 ($70.50 – $2.70) at November expiration.
Maximum loss: $6,780 if CERN goes to zero at expiration.
The strategy’s main goal is for the stock to rise up to the sold call’s strike price, $75, in this case. The stock moves up the maximum amount without being called away and the sold call expires worthless.
If the stock moves past $75, and it looks like it’s not going to slow down, then the call that was previously sold (November 75) can be bought back and a higher strike can be sold against the position to avoid assignment. This will allow the stock to remain in the portfolio and also give the position a chance to increase its return.
If the stock drops in price more than was anticipated, it makes sense to close out the entire trade (stock and short call) to avoid further losses.
The company is expected to announce earnings on Oct. 27.
