Building on Home Depot Covered Calls

Here’s an idea for a quick profit at the end of rough trading year. Buy 100 shares of Home Depot (HD) at around $19 and sell a January $20 covered call at $2. By selling the covered call at $1 above the current stock price, it’s really like entering a long position on Home Depot at only $17.

Here’s the added sweetener – Home Depot’s quarterly dividend goes ex-div on December 2. The declared dividend is $.22/share. By holding the shares through the 3rd Friday of January, you will meet the requirements to receive this dividend payment. This lowers your net entry point to $16.78. Until the last few weeks, HD hasn’t even been below $20 since the late 90s.

Maximum Upside = $322

Here’s the math:

With the decent chance that HD winds up above $20 by the 3rd Friday of January, your covered call option contract will get exercised and your shares sold for $20 each. You also get to keep the $200 premium received when you sold the covered call. You also receive the $22 quarterly dividend payment.

$2,000 (100 shares sold at $20) + $200 (covered call option premium) + $22 (quarterly dividend payment) - $1,900 (initial investment) = $322 or ~ 17% profit in only 8 weeks time.

Potential Downside

To make the covered call scenario work, you have to keep your 100 HD shares through the 3rd Friday in January. There is always the potential of some scandal (accounting or otherwise) to be revealed between now and then that causes HD’s share price to sink. Still, your theoretical entry point in this position is only $16.78 – a 9% discount over where it was when you entered the position at $19.

The other potential downside is if HD doubles in the next four weeks and you feel sick about missing out on the $1,900 gain you could have realized in the unlikely event that were to happen. You never know…..

Feeling lucky? Multiply the numbers above by 10. Get long with 1,000 HD shares and sell 10 January 20 covered call contracts and your maximum upside becomes $3,220.

Disclosure: no positions