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Sirius XM Radio (SIRI) has certainly been a volatile stock over the past two years. The shares began 2011 at $1.63, rose 50% to $2.44 by the end of May, gave it all back and then some, falling 48% to $1.27 by early October, before rising 43% to close out the year at $1.82. When the year had ended, Sirius was up nearly 12%. It was a fairly good year for buy and hold investors, but it certainly presented traders plenty of opportunities to have significantly higher gains, especially for those able to accurately trade it in both directions.

2012 hasn't been quite as volatile, but it also has had its moments. After opening the year at $1.82, the price rose 32% to $2.41 by the beginning of April. It didn't take long to give it all back as the shares dropped 26% to $1.78 by mid-May. Since then, the shares rose 67% to a post merger high of $2.97 in mid-October, fell 14% to $2.55 a month later and bounced up 12% to $2.85 on December 4th.

During the past year Sirius XM instituted a price increase, paid down debt with a combination of cash on hand and a new 10 year loan at 5.25%, and has experienced solid growth in revenue and subscribers. The improvements in the balance sheet and fundamentals have probably contributed to the share price performance. So have the actions by the company's largest shareholder, Liberty Media (LMCA).

Not only has Liberty petitioned the FCC for permission to go to de jure control, but it has also been aggressively buying up common stock - a total of 655,823,552 common shares. These purchases, representing 17% of the 3,753,201,929 shares outstanding at the start of the year, reduced supply while increasing demand and are also likely to have contributed to the price volatility.

On December 5th, the company announced it had opened a $1.25 billion revolving credit facility, and the following day announced a special dividend of $0.05 per share and a $2 billion share buyback. The shares responded to the much anticipated share buyback announcement by drifting down to the current price of $2.73.

With all of this volatility, is it any surprise that the analysts polled by Thompson Reuters showed a range of share price targets from $2.25 to $4? These analysts also have an average price target of $3.18. That average price target of $3.18, if the analysts are correct, represents a potential gain of 16% from the current price. Many investors would find a 16% gain very attractive. Some want much more than 16% and others are willing to accept less for a reduced level of volatility.

I have often been criticized for my cautious views of Sirius XM. I often open positions with simultaneous purchases of the stock and sale of call options. These returns often result in gains in the high teens and at times offer annualized yields in excess of 25%-30%. I am willing to let others take on the risk and cap my potential gains. Are you?

If the analysts are correct, the recent price of $2.73 presents an opportunity for a 25% gain with a lower target price than the analysts' average of $3.18. Does it sound too good to be true? You decide.

$3 January 2014 call options are currently trading at $0.34 Bid and $0.38 Asked. So, buying the stock for $2.73 and selling the call at $0.34 results in a net cash outlay of $2.39. Opening this transaction also entitles the investor to collect the $0.05 special dividend. If the analysts are correct and the stock price is over $3 on January 18, 2014, your calls will be assigned and you will sell the shares for $3. Since your adjusted cost basis is $2.39, your gain is:

$3 / $2.39 = 25.5%.

Add on the $0.05 dividend and the return is 27.6%. The annualized yield is a few percentage points less because there are commissions and the time period is 402 days rather than 365. Still, it's a substantial gain. The downside is that if the shares are substantially above $3, the investor sacrifices that potential gain. How much higher? Since the gain is capped at $3, the maximum gain is $0.61 - the difference between the net cost of $2.39 and the sale price of $3. To get a $0.61 gain on a straight purchase, the shares need to rise to $3.34 ($2.73 + $0.61 = $3.34). But, that's only the cash gain. Because the initial cash outlay is higher on a straight stock purchase, the percentage return is less. To get the same 25.5% return (both trades get the $0.05 dividend), the price must rise from $2.73 to $3.42. The actual breakeven could be more or less depending on the actual price realized for the call and your actual commissions, but it is within a couple of pennies either way.

Summary

Covered calls can provide an opportunity for certain investors in Sirius XM to realize substantial gains at a reduced risk. Other investors believe that the average analyst is much too conservative and think that they will be leaving too much money on the table. It all depends on where your price target is and which of the analysts have the target price correct.

I am very comfortable leaving some extra money on the table, like this type of trade, have executed it in the past, and will probably do so in the future.

Source: Sirius XM: Investing For A 25% Gain

Additional disclosure: I have $3 January 2013 covered calls against most of my SIRI position, as well as some $2 and $2.50 January 2013 and $2.50 December covered calls. I may initiate (or close) a buy stock/sell option position in SIRI at any time. Also, in addition to long-term holdings, I have recently begun day trading 10,000 share blocks of SIRI and may continue to do so. I have no position in LMCA.