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Chevron Is Right For This Option Strategy

Chevron Corporation, through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. It operates in two segments, Upstream and Downstream.  CVX has an equity score of 9.6 (VERY BULLISH) out of a 10.  This is a covered call position on Chevron Corp (CVX),

OPTION STRATEGY:

Look at the June 95 covered call. For each 100 shares of Chevron Corporation (CVX) stock you buy, sell one June 95 covered call option for an 96.70 (100.30 – 3.60) debit or better. That’s potentially a 3.4% assigned return.

STOCK TREND:

The technicals for CVX are bullish with a weak downward trend.  The stock is under distribution with support at 101.95.  S&P rates this stock 5 STARS (out of five) – strong buy.

RESEARCH NOTES:

S&P maintains strong buy recommendation on shares of Chevron Corp. (CVX) . CVX sees ’12 capex at $32.7B, up from $28B, before acquisition, expected in ’11.  Upstream is slated at $28B (87%), with major capex at LNG and deepwater projects.  We think it will comfortably fund this plan, and possibly boost dividends and buybacks via projected cash flow.  We see CVX thriving from a smaller refining footprint, where Asian exposure will help future results.  About 69% of production is higher-margin oil.  Shares have outperformed peers and benchmarks in ’11, but discounted valuations and solid near/long-term growth visibility remain highly attractive, in our view.

The Biggest Mistake New Call Writers Make

Covered call trading is not like directional trading which has an objective to time the movement of a stock in the direction it is moving.  Covered writing is a game of regular, incremental returns.  The covered call writer’s objective is to collect the option premium for income without taking any damage to the downside of owning the stock.  The secret to success for the call writer is to make smaller, more consistent returns compared to a advanced option trader who makes many bets waiting for a 50% – 100% winner.  The biggest mistake by new call writers is writing a stock solely to capture the fattest time value premiums.

To improve the chances of being successful, the call writer should focus on stock selection.  The covered call trader should focus on 3% monthly returns.  However, a 15% drawdown on a trade will require 5 months of 3% returns to recoup the loss and get back to even.  This is why the Monthly Income Plan focuses on 5 star stocks signaling high quality stocks.

Why avoid the fattest premiums for a measly 3% monthly return?  The short answer is that high premiums often signal high risk, and writing calls on these options without regard to stock quality will eventually decimate your trading account.  There are two reasons that value premium becomes high enough to offer big returns:

1)   The stock is volatile and implied volatility is in line with the stock, or

2)   Implied volatility (IV) is significantly higher than actual volatility.

Simply, the higher the rate of return, the higher either actual or implied volatility (or both) must be on the options.  If two stocks had volatility of 60% we would expect the option premiums to be roughly comparable.  What if one stock had an IV of 25%?  This indicates a market expectation of less volatility in the future but it also means the investor is not getting paid for the 60% volatility risk he is taking on.  If the other stock had IV of 80% then the investor must determine what is causing the IV to be higher than the 60% actual volatility.  This usually indicates that the market is expecting some new event on the stocks such as news, announcement, earning or more.

If the IV is in line with the stock volatility, then the options are priced fairly so the decision comes down to – do you want to invest in the stock.  The rule is to AVOID stocks with spiking IV and look for a different trade.  To be conservative, look to write calls on stocks with a volatility of 40% or less.  If you are experienced and seek more income, look for stocks with volatility between 40% and 60%.  Anything above 60% I would consider high risk so proceed with caution.  You should at least look at the volatility of the stock before you invest to know what the risk of the trade may be over the coming option period.

Covered Call Write on Advanced Auto Parts

Covered Call trade on Advanced Auto Parts (AAP).

OPTIONS STRATEGY:

Look at the December 2011 70 covered call.  For each 100 shares of Advance Auto Parts (AAP) stock you buy, sell one December 2011 70 covered call option for a 67.06 (69.31 – 2.25) debit or better. That’s potentially a 4.38% assigned return.  This stock also pays a dividend which may add another 0.1% to the return. The stocks last ex-dividend date was 9/21/2011.

TECHNICALs:

The technicals for AAP are bullish with a possible trend reversal.   The stock is under distribution with support at 64.38. S&P rates this stock 5 STARS (out of five) – strong buy.

RISK:

For those wanting downside protection, buy the March 2012 65 put for 3.50.  Sell the put when you exit the covered call.  This is optional for the covered call to protect the downside of AAP at 65.

RESEARCH NOTES:
S&P reiterates strong buy recommendation on shares of Advance Auto Parts (AAP) .   For the 12-weeks ended October 8, EPS of $1.41, vs. $1.03, is $0.22 above our estimate.   While comp-store sales rose just 2.2%, this quarter lapped an exceptional 9.9% increase in the year-ago period, providing a challenging hurdle.   We continue to favor industry fundamentals, and expect global sourcing efforts and supply chain investments to drive improved gross margins over the medium term.  As a result, we are increasing our ’11 and ’12 EPS estimates to $4.96 and $5.71 from $4.72 and $5.47, and are also raising our DCF-based target price by $5 to $85.
EARNINGS HIGHLIGHTS:
  • On 11/09/11, the company announced quarterly earnings of 1.41 per share, a positive surprise of 19.4% above the consensus 1.18.  Over the past 4 quarters, the company has reported 3 positive (>2%), 1 negative(<-2%), and 0 in-line (within 2%) surprises.  The average surprise for this time period has been 5.0%.
  • AAP’s current quarter consensus estimate has remained relatively unchanged over the past 90 days at 0.68.  Estimates within its Subsector have moved an average of 0.0% during the same time period.
  • During the past four weeks, analysts covering AAP have made 1 upward and 0 downward EPS estimate revisions for the current quarter.

Covered Call Options Strategy for United Parcel Services (UPS)

Today’s covered call trade is on United Parcel Services (UPS) that reported better than expected earnings on 10/24/2011.

United Parcel Service Inc. (UPS) reported a 5.1% increase in third-quarter earnings Tuesday that topped Wall Street’s profit forecast, although overall package volume was stagnant due to a downturn in Asian exports and slack U.S. demand.  Executives of the Atlanta-based shipping giant voiced cautious optimism for the fourth quarter nonetheless, saying that the U.S. economy appears to have stabilized and noting that Asian imports could increase in the weeks leading up to the holidays if U.S. consumer confidence improves.

OPTION STRATEGY:

Look at the December 2011 70 covered call. For each 100 shares of United Parcel Service (UPS) stock you buy, sell one December 2011 70  covered call option for a 67.72 (69.57 – 1.85) debit or better.  That’s potentially a 3.37% assigned return in 52 days for an anualized return of 23.7%.  This stock also pays a dividend which may add another 0.8% to the return. The stocks next ex-dividend date is 11/08/2011.

TECHNICALS:

The technicals for UPS are bullish with a weak upward trend.  The stock is under accumulation with support at 67.61.  S&P rates this stock 4 STARS (out of five) – buy.

STOCK RISK PROTECTION:  For those wishing to add more downside protection, buy the April 2012 67.5 put for 4.40.  Sell the put when you exit the covered call trade.

S&P RESEARCH NOTES:

S&P reiterates buy opinion on shares of United Parcel Service (UPS) . Q3 EPS of $1.06, vs. $0.93, misses our $1.10 estimate, but is $0.01 above the Capital IQ consensus forecast.  UPS saw slowing international volumes and flat U.S. volumes, but offset this with higher yields and fixed cost leverage.  UPS reaffirms prior ’11 EPS guidance of $4.15-$4.40.  We trim our ’11 and ’12 EPS estimates to $4.30 and $4.90, from $4.35 and $5.00.  We keep our 12-month target price at $95, 19X our ’12 EPS estimate, and in the middle of UPS’ 5-year historical P/E range.  We still think UPS is well positioned for an eventual rebound in the global economy.

UPS Option strategy

Click to enlarge

Covered Call and Blanket Put on Walgreen (WAG)

Walgreen covered call and protective put

Click to enlarge

Covered Call and Blanket Put on Walgreens (WAG).

STRATEGY: Look at the November 34 covered call. For each 100 shares of Walgreen Co. (WAG) stock you buy, sell one November 2011 34 covered call option for a 32.15 (33.30 – 1.35) debit or better. That’s potentially a 5.75% assigned return. This stock also pays a dividend which may add another 0.7% to the return. The stocks next ex-dividend date is projected to be 11/17/2011.

The technicals for WAG are bullish with a weak downward trend. The stock is under accumulation with support at 34.55. S&P rates this stock 4 STARS (out of five) – buy.

RISK: To protect you capital, you should look at buying the Apr 2012 33 Put at 3.50. This will limit your downsize to the put strike price of 33. And you can continue to sell calls each month for premium as long as the trade is still working. The initial trade risk is $2.45 (see chart) but this will decrease for each additional call sold in the months following November expiration.  When you exit the covered call you will sell the Apr 2012 33 Put at market value to recoup some of your protective put cost.

S&P research notes: S&P reiterates buy recommendation on shares of Walgreen Co. (WAG). WAG reports Aug-Q operating EPS of $0.57, vs. $0.49, in line with our estimate and $0.02 above consensus from Capital IQ. We believe the shares may experience near-term pressure due to tense contract negotiations with Express Scripts (ESRX) . However, we think an agreement will be reached before expiration or shortly after expiration of the current contract. Due to greater than expected non-pharmacy margin pressures as consumers trade down, we are reducing our FY 12 (Aug.) EPS projection $0.06 to $3.04, and our 12-month target price by $7 to $40, on comparative analysis.

Covered Call Recommendation on Berkshire Hathaway B Shares

Covered Call Recommendation on Berkshire Hathaway B (BRK.B) trading at $72.09

Strategy: Look to sell one October 2011 72.5 call for wach 100 shares of Berkshire Hathaway (BRK.B).  The net debit will be $69.89 (72.09-2.20) for an assigned return of 3.73% in 24 days or 56.8% annualized.

Research Notes:  This is the first time Berkshire has bought back its own shares.  It tells us that the world’s best investor, Warren Buffett, thinks his own business is dirt-cheap.

Berkshire has plenty of cash to commit to this program – $48 billion of it. And the company announced it was willing to pay up to 1.1 times book value for its own stock… which means it’s willing to pay nearly $109,000 per “A” share or roughly $72.50 per “B” share. (These numbers are not exact, just close and easy to remember.)

This creates a “floor” in the stock price.   Any time the stock falls much below that, Berkshire will buy it… or investors will buy it thinking that Berkshire will. As I write, both share classes are below those prices.

I like it… Your downside is limited thanks to the new buyback creating a “floor.”  Meanwhile, Warren Buffett, the world’s greatest investor, is managing your money.  This is a trade that can be updated each month so that the call premium recieved is monthly income.  WOW!  I like getting monthly income from Warren Buffett.

Defensive Covered Call Strategy on Apache Corp (APA)

This is a defensive in-the-money covered call recommendation on Apache Corporation setup as an income investment.

Covered Call Strategy:

Look at the January 85 covered call. For each 100 shares of Apache Corporation (APA) stock you buy, sell one January 85 covered call option for an 80.08 (94.63 – 14.55) debit or better. That’s potentially a 6.1% assigned return. This stock also pays a dividend which may add another 0.4% to the return. The stocks last ex-dividend date was 7/20/2011.  S&P rates the stock as 5 stars (strong buy).  The stock has to drop 15.4% to threaten the breakeven point.

S&P research notes:

 S&P maintains strong buy recommendation on shares of Apache Corp (APA) .  APA plans to acquire ExxonMobil’s (XOM) Beryl and other North Sea fields for $1.75B(expected Q4 close), lifting North Sea production and reserves 54% and 44%, respectively (65% liquids).  North Sea success at Forties (doubled reserves since ’03) should aid to maximize Beryl opportunities.  APA boosts exposure to higher-priced Brent crude and UK natural gas. North Sea will represent 11% of production (7% prior). We find APA’s balance sheet superior with debt-to-capital of 23%, cash of $1.1B, and capital flexibility vs. peers, and see valuation as compelling.
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