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Posts Tagged ‘cover call’

Adding a Put to a Covered Call

When you buy a put for a covered call trade, you then have both a sold call and bought put on the stock you own.  This is called a “collar” as you have a  protective put on a covered call.  The classic collar has an at-the-money (ATM) call and put at the same strike price.  In the case of the covered call trader, the  bought put serves as additional downsize protection against a stock price decline.

When you add a put to a covered call trade, you are adding additional cost to the trade.  This will increase your cost basis for the trade. However, you can create a totally riskless covered call trade.  Let’s look at an example using XYZ.

XYZ is trading at $74.77 in the market.  You can sell the 75 Call for $4.20 and buy the 75 Put for $4.00.  If the stock is above 75 at closing, if will be called away and you gain $0.43 in profits (75-74.77+.20).  Additionally, we could sell the put if there is any value left before expiration.  In this scenario, you make money from the covered call side.

If XYZ is trading below 75 at expiration, the call will expire worthless but the put will have value.  You would exercise the 75 put which will give you $75.00 for the stock shares trading below the 75 strike price.  You would then make a profit of $0.43 on the protective put side of the trade.

Stock Price         74.77
Sell 75 Call           4.20
Buy 75 Put           4.00
Net Premium           0.20
Net Cost         74.57
Downside Risk                –
Max Profit           0.43


This trade is a risk-free trade because the total cost basis ($74.57) is below both strike prices of 75.  Regardless of what happens to the stock price, you will receive $75.00 for your stock. You can say that this collar trade is an arbitrage trade because there was a positive difference between the call and put prices at the 75 strike price.  The return of $0.43 is only a 0.58% return.  When you add trading commissions to the cost basis, this can’t be arbitraged by a retail investor.  For more active traders, you can vary your timing of closing the call and put sides to increase your profit.  For example, when the sold call loses the majority of value, you can close this side by buying to close the call.  Then, you will own the stock with the put guarentee at the strike price.  There are numerous possibilities when you actively managed the collar trade if you make adjustments before expiration.

You can construct a similar trade with different strike prices for the call and put.  When you vary the strike prices this, you are changing the cost basis and risk exposure.  For example with the 75 covered call on XYZ, we might buy the 72.5 put for $3.15 (see table below).  This will give us a max profit of $1.05 and downsize risk of $1.22.

XYZ Stock
Stock Price         74.77
Sell 75 Call           4.20
Buy 72.5 Put           3.15
Net Premium           1.05
Net Cost         73.72
Downside Risk           1.22
Max Profit           1.05


The great part about this type of trade is that you are limiting the amount of downsize by using the blanket put.  If the stock market bottom falls out with a 10% correction, you will only lose $1.22 per covered call or 1.65%.

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Covered Call Write on JP Morgan Chase (JPM)

Covered Call Recommedation on JP Morgan Chase (JPM) currently trading at $31.30.

STRATEGY:  Look at the March 25 covered call. For each 100 shares of JP Morgan (JPM) stock you buy, sell one March 25 covered call option for a 29.40 (31.30 – 1.90) debit or better. That’s potentially a 5.4% assigned return in 32 days.

Risk:   The technicals for JPM are bearish with a possible trend reversal.  The stock is under accumulation with support at 30.11.  S&P rates this stock 4 STARS (out of five) – buy.  The stock has to drop 6.5% to fall to the breakeven level.
Protective Put:  Those seeking more protection may look at purchasing the March 2012 30 put at $3.15.  Sell the put when you exit the covered call position.
S&P Research Notes:  S&P maintains buy recommendation on shares of JP Morgan Chase and Co (JPM).  Q3 EPS of $1.02, vs. $1.01, misses our estimate of $1.10 on higher than expected loan loss provisions.  As we expected, investment banking and trading fell significantly from Q2. However, credit card revenues, net interest income, and mortgage fees were in line with our expectations.  Quality of earnings improved greatly as reserve releases were relatively small.  We lower our ’11 EPS forecast to $4.67, from $4.87.  We also reduce our target price by $5 to $47, based on a slight premium to peers 10.0X multiple on our forward four quarters EPS projection of $4.76.

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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.

Free Covered Call Trade

Free covered call recommendation on Alkermes is a stock and call setup for income investment.


Look at the November 16 covered call. For each 100 shares of Alkermes (ALKS) stock you buy, sell one November 16 covered call option for a 14.78 (16.13 – 1.35) debit or better. That’s potentially a 8.3% assigned return on investment.

 The technicals for ALKS are bearish with a weak downward trend. The stock is under accumulation with support at 15.70. S&P rates this stock 4 STARS (out of five) – buy.
 S&P maintains Buy opinion on shares of Alkermes (ALKS). ALKS completes its acquisition of Elan Drug Technologies for $1.02B, consisting of $500M in cash and issuance of 31.9M of its shares. We continue to see the deal significantly diversifying revenues with royalties from products with long patent lives, thus lowering its risk profile. We also see robust cash flows supporting a rapidly advancing R&D pipeline. On anticipated earnings accretion, we raise our adjusted FY 12 (Mar.) EPS estimate $0.47 to $0.08 and FY 13’s by $0.79 to $1.02. We keep our target price at $22, which reflects the expected benefits from the deal.
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Risk-On Relief Rally with Amazon Covered Call

After another large decline last Thursday, equities  along with other “risk-on” assets appear poised for a relief rally that could  come early in the week as the markets begin anticipating and debating what  Federal Reserve Chairman Ben Bernanke may deliver in his Friday speech. It was  in last year’s speech from Jackson Hole when the Chairman unveiled QE2 setting  the stage for an equity rally that helped to boost the S&P 500 Index by 32%  before reaching a top on May 2, 2011. Although the early comments do not  reflect high expectations, unless there is news of more negative developments  in Europe chances are we can expect some short covering before the speech,  after all nobody knows what he may pull out of his hat.

Here is a FREE Covered Call Trade:

Covered Call STRATEGY:

Look at the January 160 covered call. For each 100 shares of (AMZN) stock you buy, sell one January 160 covered call option for a 147.40 (180.55 – 33.15) debit or better. That’s potentially an 8.5% assigned return.   The technicals for AMZN are bearish with a possible trend reversal. The stock is under distribution with support at 175.37. S&P rates this stock 4 STARS (out of five) – buy.   The stock has to drop 18.4% to threaten the breakeven point.

S&P upgrades recommendation on shares of (AMZN) to buy from hold. Here are the notes: Following a recent 20% decline, we think AMZN is attractively priced trading well below our $250 DCF-based target price. While we expect continued near-term investments in fulfillment and technology to weigh on the bottom line over the next several quarters, we believe AMZN has a significant opportunity for long-term operating margin growth. We think industry drivers remain positive, with worldwide online penetration growth and with more people choosing to shop online. In addition, AMZN’s recent sales execution and market share gains have been peerless, in our opinion.

Covered Call Trade on Gold

Closing out yesterday, stocks were soundly beaten amid growing fears of a global recession, as investors confronted a grim mix of U.S. economic data and fresh concerns about Europe’s banks.  In the flight to safety, investors piled into gold, which jumped to a new record of nearly $1,830 a troy ounce.  If you believe the trend in gold will be mainatined due to market uncertainty, why not look at gold for a covered call.  Why use a covered call when rather than go long gold?  The simple rationale is that gold has had a nice runup over the last few weeks and if the market views turn positive, then some of that money will come back into stocks and gold retraces or pulls back from current prices.  With this thought in mind, you may want to sell an in-the-money call to add some downside pretection.

The covered call can be placed on the gold ETF (GLD) which was upgraded by Ned Davis Research from 4 stars to 5 stars this week.  If you want to be more aggressive, you can do a covered call on the gold mimers ETF (GDX) with an in-the-money call.  The chart below shows the assigned returns at various strike prices for GLD and GDX.

Covered call trades on gold and gold miners

Click to enlarge

Monthly Income Investment Using Covered Call Trade on Deere and Company (DE)

Deere is currently trading at $73.83 and is rated a buy with 4 stars by S&P.  This is setting up nicely for a monthly income investment with a deep-in-the-money covered call.

Strategy:  Look at the September 70 covered call. For each 100 shares of Deere (DE) stock you buy, sell one September 70 covered call option for a 68.13 (73.83 – 5.70) debit or better. That’s potentially a 2.75% assigned return on investment. This gives you almost 8% downside protection for the next option month.   The technicals for DE are bearish with a weak downward trend.  The stock is under accumulation with support at 66.06.
The long-term investor can look at the December 70 call trading at $8.30 at this time.  This adds $2.60 more in premium compared to the September 70 call ($5.70).  The December trade will net a 6% return on investment if assigned.
Research Notes: S&P maintains buy opinion on shares of Deere (DE).   Jul-Q EPS of$1.69, vs. $1.44, is $0.09 below forecast, as 24% rise in equipment sales was partly offset by higher materials costs. Despite greater economic uncertainty, we see ongoing gains in demand for DE’s equipment. We also think its long-term trends are favorable, on growing needs for food, shelter and infrastructure. We keep our FY 11 (Oct.) EPS estimate at $6.40 and FY 12’s at $7.60. However, on reduced economic visibility, we cut our target price by $16 to $99.
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