Today, I’ll share a recent trade, another covered call. This time on Radio Shack. Let me show you the details and then I’ll walk you through how this trade might play out.
Radio Shack recently tumbled, from a 52 week high of $16.70 to a recent low of $7.15 due to a bad earnings report and weak consumer confidence. This short term drop presented a spike in volatility that may be a opportunity to use options. A Jan ’13 $7.50 call which is just out of the money was trading at nearly 20% of the stock price which is an unusually high premium. In comparison, options at the same expiration for McDonald’s will trade at less than 6% of the stock value. For the Radio Shack trade, I bought 1000 shares at $7.29 and sold 10 contracts against those shares for $1.24. My net out of pocket is $6.05 per share or $6050 for a stock currently worth $7290. In effect, I bought it at a 17% discount. On the other hand, my profit potential is severely limited. No matter how high the stock rises, I am obligated to let it go for $7.50 per share. If it trades above $7.00 or so, the call buyer may call it early to capture the 50 cent dividend which is scheduled for November. If that happens, this trade will show a 24% return in 10 month’s time.
As far as the fundamentals go, Radio Shack is not buried in debt, their cash and debt are nearly identical, and book value $8.01 per share. I don’t imagine a further crash and burn from here, but a potential takeover.
Update March 2015 – A bust. RSH went under, bankrupt. Lesson – Book value doesn’t mean everything, it’s not a guaranteed floor. On thr flip side, companies with negative book values have been known to grow, turn a profit and succeed.