Order placed Monday morning:
2009-May-11
BUY +1,000 USO @ 32.14
SELL -10 USO Oct 09 30 CALL @ 5.00
USO - Risk Profile
Downside Break Even Point
(Net Investment – Dividends) / Shares Held
(27,140 – 0) / 1,000 = 27.14
Percent Downside Protection
(Initial Stock Price – Break Even Price) / Original Stock Price
(32.14 – 27.14) / 32.14 = 15.5%
Return if Unchanged
(Unchanged Stock Value + Dividends – Net Investment) / Net Investment
(32,140 + 0 – 27,140) / 27,140 = 18.4%
The play I am going to make for the covered call will be a play on crude oil through the United States Oil ETF (USO). The justification for this play is purely technical as is indicated from th chart below we recently crossed an area that finished the formation of a nice cup with handle pattern. Fundamentally I do not have faith in this market and I believe if we retrace to our lows that oil will follow. So even though I am modestly bearish I am going to write the covered call on USO because I feel we can still stay within a range here with oil and could be good neutral play on selling the premiums here. Ideally we would see a pullback to the line drawn to indicate a support level has been made before executing, however I will move forward without the confirmation.
Note: This is not a clean breakout so the support line may prove to be resistance. Something to keep an eye on.
USO - Cup with Handle Pattern
Some quick basics,
Call options as defined by optionetics.com “.. give the buyer the right, but not the obligation, to purchase an underlying asset.” In short if you buy (long) a call option you have the right to purchase the underlying stock at the strike price of the option if it has gone ‘in the money’ (ITM). For example if you purchase a call option for XYZ at a strike of 15 if the stock price of XYZ increases in value such that it is higher than $15 before the option expires you have the right to purchase XYZ at the $15 price. Options expire on the Saturday of the 3rd week of the option expiration month, but can not be traded after the Friday of that same week. If your call option is out of the money, meaning the stock price is at 15 or less the option expires worthless. 1 call option represents the right to buy 100 shares of the underlying stock. Essentially you get to buy the stock at a lower price if everything works out, or you call sell your option back on the market for a profit it has gone far enough ITM. The price of the option includes the intrinsic value, which is the amount the option is ITM, plus the premium, or time value which is associated with the risk or volatility of the underlying asset. For more information on options head on over to optionetics.com.
The first strategy I will be utilizing is considered the most basic beginner strategy for options investors, the covered call. The idea behind the covered call is to buy stock, while simultaneously selling a call.
Basic Principle:
- Buy Stock
- Sell Call
Positives: downside protection
Negatives: limits profit from bullish stock moves
Example:
- Buy 100 XYZ @ 48
- Sell July 50 Call @ 3
Maximum potential profit = Strike price – Stock price + Call price
Downside break even = Stock price – Call price
Notes: ITM options offer better downside protection, OTM offers more potential profit.
Risk Profile:
Covered Call Risk Profile
Rules:
- use conditional orders (buy stock and sell call at same time)
- min monthly return if stock is unchanged = +1%
- min downside protection = 10% or 5% in the money
That is all on the strategy. Any follow up to the covered call will be analyzed as it occurs. Next post will outline the analysis of the position I am going to take. In this case it will be a position on oil through USO. Check back soon.
aj
