With earnings season upon us, it is essential to be cautious about entering trades in companies that haven’t yet announced their results, unless that is your strategy. However, with the right names, you can make money before and after the announcements, which is the basis for today’s trade.
Tiffany & Co. (NYSE:TIF) looks like a diamond in the rough. This high-end jewelry retailer, designer and manufacturer is known throughout the world. It has pretty solid fundamentals and looks balanced financially, with a nice record of earnings-per-share growth.
TIF is expected to announce earnings Nov. 29 and today’s trade idea, a covered call, uses options that expire shortly before their news comes out.
With covered calls, it’s often prudent to not pick a stock with a pending announcement, because the stock can lose more value than anticipated if the news is interpreted as being less-than-positive.
A covered call is when a trader or investor buys stock or already owns stock and, at the same time, sells a call as part of the same trade. This strategy can generate additional income for a stock position.
Another benefit of a covered call is that it is like purchasing the stock at a discount rate. The credit received from the short call offsets the purchase price of the shares of stock. In essence, the short call lowers the breakeven point on the trade. This is especially beneficial if the stock drops in price some.
TIF recently came off its six-month low at around $56. The stock had a nice run-up in October and has gotten above its 200-day moving average again, which is a bullish sign.
The stock might take a breather before deciding to go higher, and it has the 200-day moving average just below the current price as support. Because the market has been unpredictable as of late, a covered call might give this trade a chance to profit nicely. A strike price of $75 by November expiration is a nice area to target.
Making the TIF Covered Call Trade
With TIF trading at $72.39…
Example: Buy 100 shares of TIF @ $72.39 and sell the Nov 75 Call @ $2.89
Cost of the stock: 100 X $72.39 = $7,239 debit
Premium received: 100 X $2.89 = $289 credit
Maximum profit: $550 — that’s $261 ($75 stock target – $72.39 current price X 100) from the stock and $289 from the premium received if TIF finishes at or above $75 @ November expiration.
Breakeven: If TIF finishes at $69.50 ($72.39 – $2.89) @ November expiration.
Maximum loss: $6,950, which occurs in the unlikely event that TIF goes to $0 @ November expiration.
Managing the TIF Covered Call Trade
The main objective for a covered call strategy is for the stock to just rise up to the sold call’s $75 strike price. The stock moves up the maximum amount without being called away, and the sold call expires worthless.
The breakeven point of the trade is structured to be at nice area of support (200-day moving average) in the $69 area.
If the stock drops in price more than was anticipated, it might make sense to close out the entire trade (stock and short call) to avoid further losses.
