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Posts Tagged ‘downside protection’

Writing Deep-In-The-Money Covered Calls For Protection

The conservative covered call writer is seeking downside protection and income from premium.  This investor places more value on protecting capital and is not concerned about their stock being called away.  This covered call investor will sell calls that are deep-in-the-money (ITM).  This is a good strategy when the market uncertainty increases and there is increasing worry about a market correction.

For example, if XYZ is trading at $53.00 then a deep ITM call will be sold at the 45 strike price.  This call is $8.00 ITM and provides a 15% downside protection.  With a stable stock like XYZ, it probably will not go below the 45 strike price during a market pullback.  In fact, XYZ has not been below $45.00 in the last three years.

The trade-off for selling ITM calls is that the returns will be lower as the majority of the call premium is intrinsic value.  The method to the madness is that these calls offer more downside protection in return to accepting a lower time value of premium.  ITM call writes can be a very successful strategy when used on large-cap stocks during a martket pullback.

There are many covered call traders that suggests they made a higher return over a long time period for several reasons:

  • It is not that difficult to find a 3% return with 30 days remaining on high quality stocks;
  • The stocks will be assigned at expiration so you are never stuck with a stock that is down;
  • ITM calls have a higher delta so they lose value closer to the stock.  You can easily roll down your strike price without a loss;
  • Trading the short call is more profitable due to the high delta.  Here trading refers to buying back the call on a price dip and write them again on the bounce back.

The ITM writer should concentrate on large-cap, high quality stocks as there is never a reason to trade poor quality stocks regardless of your strategy with ITM calls.  The one item of note is that this strategy is not the best in a rising bull market unless you have a high risk avoidance to a potential trade loss.

A variation of this trade is to use it when volatility is high such as in the financial crisis in 2009.  The high volatility will increase the amount of premium and return.  You can use this strategy when there is a pending event such as an earnings release but not as a speculation trade.  the key is to use this strategy with large-cap, high quality stocks.

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3 Dividend Stocks for a Weak Market

In recent weeks, the bears are starting to get the upper hand.  The S&P 500 may have problems keeping its 20% return year to date.  Investors should get more cautious with their stock holdings.  We believe that when pullbacks happen, dividend stocks fare better than others because their yields provide downside protection.  Then, how about stocks that have a current yield above 3.5%, have 10% earnings per share growth projections and have prices that are up more than 10% in the past 13 weeks.

Income provides a return when the market is vacillating on its next direction.  Add this to stocks in an uptrend and with projected growth, investors should be positioned for above market returns in the coming months.  Here are three stocks to watch;

Orchids Paper Products (TIS) has a high dividend yield of 5.05%.  The stock is up 15.9% in the last 13 weeks.  EPS is projected to increase 9.7% next year compared to this year.  Orchids provided investors with dividend increases in both the 1st quarter and 2nd quarter.  The company has increased dividends 75% in the past year.

Orchids Paper is a small cap with only $220 million in market cap.  The company established a new quarterly record for both total net sales and converted product net sales of $29.2 million and $27.8 million, respectively.  Net income per share for the second quarter 2013 was $0.39 per diluted share compared with $0.29 per diluted share in the same period in 2012.


Company efforts in new product development continue to enhance their product offering line-up for the mid and premium-tier markets which continues to resonate well with the market and is the major driver of recent business growth.

First Call has a strong buy recommendation with a 1.3 stock rating.

Bank holding company UMPQUA Holdings (UMPQ) has a high dividend yield of 3.58%.  The stock is up 23.3% in the last 13 weeks.  EPS is projected to increase 10.1% next year compared to this year.  UMPQUA provided investors with dividend increases in both the 1st quarter and 2nd quarter.  The company has increased dividends 67% in the past year.

The Company had second quarter 2013 net earnings of $26.1 million, or $0.23 per diluted common share, compared to net earnings of $23.2 million, or $0.21per diluted common share for the first quarter of 2013, and $23.1 million, or $0.21 per diluted common share, for the same period in the prior year.

For the six months ended June 30, 2013, the Company reported net earnings of $49.2 million, or $0.44per diluted common share, compared to net earnings of $48.5 million, or $0.43 per diluted common share for the same period of the prior year.

It was another solid quarter for Umpqua, highlighted by strong earnings, increasing capital returns to shareholders, continued loan growth and the Financial Pacific Leasing acquisition. Umpqua Bank’s acquisition of FinPac which closed on July 1, 2013, has expected earnings accretion of at least 14% in the first full year.

Valassis Communications (VCI) has a high dividend yield of 4.35%.  The stock is up 13.1% in the last 13 weeks.  EPS is projected to increase 11.6% next year compared to this year.  Valassis started paying dividends to investors in the 4th quarter of 2012.  The Company expects to use approximately 35-40% of free cash flow* for stock repurchases during 2013.

Valassis, which sells space for advertising and coupons in its four-color booklets, reported a profit of $26.8 million, or $0.68 a share, compared with $21.7 million, or $0.51 a share, a year earlier.  Valassis’ second-quarter profit jumped 24% as the company came up against a year-earlier period bogged down by large one-time charges, while core earnings fell below analyst estimates.

Based on the current plan and outlook, the Company reiterated full-year 2013 guidance with earnings per share between $3.05 and $3.20,  adjusted EBITDA of between $290.0 million and $300.0 million, and capital expenditures of approximately $25 million.

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