General Electric (GE) had a good run since trading between $18 and $19 in the middle of 2012. The stock has gained about 24% since then. Its performance in 2013 has also been solid, with a 15% rise since the start of the year. Now, the stock looks overbought in the short term. This has created an opportunity for investors to protect their long position and possibly add to gains with a covered call strategy.
The long-term outlook for General Electric remains strong. I just think that the stock is due for a pullback. The company is expected to grow earnings annually at 11% for the next five years. However, the current 2013 rally has already exceeded 11%. Pullbacks of about 5% are typical for GE from overbought levels.
To protect your investment and possibly make money from this scenario, investors may want to employ a covered call strategy. This strategy involves selling a call option for every 100 shares owned. If we look out to March expiration, (Friday March 15), we have the March $23 call selling for about 59 cents. If we sell a March $23 call for every 100 shares owned, investors will be anticipating that the stock falls below $23 and either remains below $23 until expiration or falls enough to make a profit. If the stock does drop below $23 by expiration, it will expire worthless. Since the call was sold, investors will collect $59 for every call sold (every 100 shares owned).
If an investor owned 100 shares, the $59 premium that was collected could be viewed as an extra dividend payment. This would amount to a yield of about 2.5% in less than one month.
What could go wrong?
The stock could continue to rally or remain above $23. I don't really see any reason why the stock would jump much higher from here. The next earnings report is not until April 19, and I don't see any major catalysts that will propel the stock much higher in the near term. Nevertheless, the possibility exists. This wouldn't be a terrible thing since investors are already long the stock. However, the call option that was sold could rise, causing the investor to close the option position for a loss. The delta of the March $23 call is about 0.67. This means that for every $1 move in the stock price, the call option value will move 67%. Therefore, if the stock price moved from $23 to $24, the call would move from $0.59 to $0.99. This would result in a loss of $40 for every call sold.
The overall market was in the process of pulling back a bit this week from overbought levels. It looks like it still has a little more room to fall. With that in mind, I think that the risk/reward is good for this strategy.
For the long term, General Electric still looks attractive. The stock pays a dividend of 3.2%. The company looks undervalued with a forward PE of 12.7, a PEG of 1.27, and a price-to-book ratio of 1.98. GE's expected annual earnings growth of 11% should allow for steady gains over the next five years. Therefore, those who don't wish to participate in the options strategy can merely hold onto the stock. Investors who agree with my short-term outlook and are comfortable with the covered call strategy have a chance to collect some premium over the next few weeks.