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Micron Technology Covered Call

Today, let’s look at another covered call trade.

Micron Technology (MU) trades at $7.10. Here is the option table for January 2013:

The $7.50 strike looks interesting to me. If you buy 1000 shares of the stock, and sell 10 of this call, your out of pocket is $5270. This is 26% below the current price. If Micron doesn’t move at all in the next 16 months, you still own the shares, but are 35% ahead. If the stock trades above $7.50, it can get called away, and the maximum gain on this trade is 42%.

A glance at key statistics shows cash ($2.4B) far higher than debt ($1.57B) and a book value per share of $8.55. Keep in mind, there’s always risk when purchasing individual stocks, this trade should be part of a well thought out portfolio. In general, these are the covered call trades I like, where the premiums are high enough that even a 15% drop in the stock price over a year’s time will still result in a profitable trade.

Note & Disclosure – I executed this trade today, and updated the numbers to reflect actual trade. The call was sold for $1.83, lower than the $1.97 above as the stock was at $7.10 when the trade occurred.

Update – 9/15/11 Bought for out of pocket $5270, 1/18/13 sold for $7491, as mentioned above, a 42% return. This was over a period of 491 days for a simple annual return of 31.2%/yr.
On Jan 18th, Micron closed at $7.89, so the stock rose 11% during this time. In hindsight, this trade was ideal. The stock closed only a bit above the strike price, so no money was left on the table. For the stock buyer to get the same 42% return, Micron would have had to close above $10. The fellow that bought the option paid me $1.97 but was only in the money for $0.39 so he lost $1.58 per share, being correct the stock would rise, but it didn’t rise nearly enough to put him in the black.

On a final note, you can see this to be a case where an option trade was less risky than simply buying the stock. Could Micron have dropped in price? Of course. Had it fallen more than 26%, I’d still have a loss. If it had gone above $10 or so, I’d have gained less than those just buying the shares. I gave up some potential gain to lower my cost. Trades like this don’t come around every day. You can see exactly why I thought this to be a valuable trade going into it. I’ll continue to share my option experience, the bad as well as the good.

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Intel Covered Call Strategy

I recently fielded a question asking about a trade suggested by a Seeking Alpha article Intel: Dividend Champion in the Making. It’s a basic strategy called a “Covered Call.” You know what a Call is, a Covered Call is simply when you own the stock and sell the call (“sell to open”) indication that you are willing to give up the stock for the strike price, and pocket the premium at the time of sale.

Let’s look at exactly what this trade entails. First, you buy the 100 shares on Intel (INTC), which would cost you $2138. Seeking Alpha suggests selling a Sept $23 call, which closed today bid $0.43. (At the time SA published their article, it was selling at $0.55) With 3 months until expiration, this can be looked at as a 2% boost, or an extra 8% annualized. On the other side of this trade is the buyer who sees a potential high return should Intel trade over $23 within the next 3 months.

Another way to look at this trade is that you are buying Intel at a 2% discount, but then are obligated to sell at $23 should it trade above that. If the stock is called away, your maximum gain is about 9.8%, not bad for a 3 month trade. This strategy can go either way, well chosen stocks might give you the opportunity to sell the call a number of times, but then sold when they run up, and you’d move on. A stock slowly trending sideways over the long term can provide quite the yield to you. Have you ever sold a covered call? Was it a trade you’d make again, or were you sorry you did it?

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Dow 20000?

Today, I’ll talk about James Altucher‘s appearance on CNBC this week,  in which he made the case for Dow 20,000 within the next 12-18 months. I had two directions I could go with this, but for today, I’ll answer the first question I had – “If this is so, how can I use an options strategy to leverage this [insanely] high forecast?” For sake of context, and the chance this is read years from now, the Dow closed this week at 12,151, so 20,000 represents a 65% increase from this point. I’ve taken the liberty of switching to the S&P to implement the strategy I’ll discuss, as the options tend to be available in better volume at the strike prices that interest me. With the S&P at 1300, a 65% upside means Mr. Altucher is looking for about 2140 for this index. To trade on the S&P, I look to its most common ETF, the SPY.

(Note – you can right-click this image to see it more clearly) The SPY trades for 1/10 the value of the S&P, so the 65% upside would put it at 214 or so. A 65% increase sounds great, right? I will now show you how through the use of options, you can a 10 fold return if this prediction is only half right. You see, the market can have some wild swings, from a low of 666 in March of 2009 it more than doubled to its recent peak of 1344. Still, let’s look at a strategy to go for the big return with a much higher chance of success.

These are the Call Options for SPY, with an expiration date in Jan, 2013. If you buy the 170 call, you will spend $62 (options trade in lots of 100), and will see a profit once the SPY exceeds 170.62. By also selling the 175 call for $26, you reduce your cost to $36, and if the S&P closes just 34% higher from today, 1750, you will see $500 for your $36, a 10 to 1 return. If your brokerage account is set up for options trading, you can actually do this. There are two commissions involved, usually less than $10 for the two purchases, so your cost will be closer to $50 which is why I say 10 to 1. If you are convinced this rise is imminent, and willing to make a higher wager, the commission will be a far lower percent of your cost, and the trade will look like a 13 to 1 return.

Here’s a chart that may help illustrate this idea a bit better. A final note – This post should be considered an observation, not a recommendation. Think of it this way – the market is willing to bet you at 13 to 1 odds that the S&P will not be over 1750 on the third Friday of January, 2013.

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Welcome to Stock Options Cafe

For some time I’ve been thinking of launching a site about options. The idea that one can make a small bet (I’ll explain why I alternate between the word ‘bet’ and ‘investment on this site.’) and if right, can get a large return has intrigued me for 30 years, I’ve been trading options for as long as I’ve been trading stocks.

If you have no idea what options are, be patient, as I will offer articles describing exactly how they work.

If you’ve traded options, I hope to offer you a different perspective, as we each approach any investment from a bit of a different angle. I offer strategies that are less common than the simple buying or selling.

For now, the site is sparse, it seemed better to get going than to perseverate over headers, logos, etc.

Joe

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