Qualcomm (NASDAQ: QCOM) investors have been presented with an opportunity to make an extra 4 percent return until January 2018 by implementing a very limited-risk options strategy. This article will elaborate on the strategy, the maximum return potential, the risks involved, and the necessary requirements.
I understand that not everyone is acquainted with options, and therefore, I will lay down every possible strategy detail to make it easier to understand and better to implement.
The monthly Qualcomm price chart below marks the period from 1999 to date. The beauty of this technical price chart lies in the simplicity and the information it provides.
One can clearly see that Qualcomm has been trading on an upward sloping support trendline since 1999. The market offered investors to buy the stock at this support level in January this year when I first recommended a buy call at $45.82. Since then, the stock has given a massive return of 50 percent, going by the current market price of $67.31.
There is also the broader channel which the stock continues to respect. I see the stock holding this range for at least a year or so. Since I mentioned January 2018 earlier, I have taken the liberty to extrapolate this range to that point, and found that the stock will have the support at $50 while the resistance will be close to $95.
Interestingly, the stock is in the middle (approx.) of this range, and investors don't really have to wait for a price appreciation to make money. The strategy that I am going to recommend will additionally compensate investors for the time they are willing to dedicate to their stock investment.
The short strangle strategy requires an investor to sell an equal number of out of the money call and put options, both expiring on the same date. As I do not expect Qualcomm to trade beyond its long-term range in the next 14 months, I can advise shorting the $95 call option and the $50 put option, both expiring on January 19, 2018.
Note: It is essential that anyone who employs this strategy holds Qualcomm shares. I have deliberately omitted the commissions and the fees for easier calculations and understanding.
From the latest data available, it can be seen that QCOM's $95 call last traded for $0.53 on Friday. The market currently sees a strong 90 percent probability of this option expiring worthless. This means that our current estimate of the $95 strong resistance is correct as well.
So, if an investor were to sell this call option, he can expect to receive $0.53 in income.
Similarly, selling the $50 put option should have brought an income of $2.58 (last traded price), but we have to adjust it for the last bid-ask range of $2.35-$2.42. For simpler calculations, I am expecting that the put option will be sold for $2.42.
The current odds of this put option expiring worthless are 84 percent. The probability of the put option expiring at zero is less than that of the call option because it is closer to the current market price of the stock, and is therefore more achievable.
Therefore, selling both the options will bring an investor a total income of $0.53 + $2.42 = $2.95. At the current price, this translates into a potential return of 4.4 percent until the expiration date.
So, an investor can boost his returns and be compensated for the time even if the stock were to languish inside the range.
Some investors might feel that it is too less of an income to be compensated for the risk they are taking. To them, I want to assure that by taking this big a range, we have already reduced the loss potential. Secondly, they should not take the numbers only in the absolute sense and try to understand what they mean.
The fact that option premiums are less right now also indicates that the market does not believe that the stock will see significant fluctuations in the next year. This is also on the strong basis that the market is forward looking.
Point Of Maximum Return
Normally, the higher the stock price goes, the better it is for investors. However, this strategy sees the maximum return flat-lining beyond the higher strike price.
If the stock closes at $95 on the expiration date, an investor will benefit doubly from the options income (4.4%) plus stock price appreciation. As per the current market price, a level of $95 would represent a return of 41.14%. Therefore, the total return will be 45.54%.
Risks To The Strategy
The primary assumption here is that the stock maintains its channel until the options expiry date. However, the stock price tracks the earnings trend. According to Yahoo Finance, analysts are current expecting an earnings growth of 4.80 percent for the next year and of 10.50% for the next five years. This should be enough to protect the stock from any shock fall and simultaneously limit any runaway rallies. But if these estimates are way off and the stock breaks out of this range, the risk will be only on the downside. On the upside, any loss from the short call will be nullified by the shares held.
I clearly do not expect the stock to trade below the long-term support. But, if my view is proved incorrect by the market, then an investor will have to choose from either adding on more shares for capturing the attractive, consistent, sustainable dividend income for the long term at attractive prices or sit on the sidelines.
Source: Qualcomm Executive Presentation
Another important part that an investor must understand before executing this strategy is the commissions and fees involved. It is indispensable that an investor consults s broker before implementation and gets a fair idea of how much the return will be undercut.
Qualcomm investors can improve their stock returns by implementing an easy to understand, limited risk options strategy. They can easily achieve more than 4 percent until January 2018.
The short strangle options strategy will ensure that an investor be fairly compensated for the time he is willing to give to his investment. The broad range should ensure that the stock does not pierce $50-$95 in the next 14 months.
It is imperative that the investor consults with a broker regarding the commissions and the fees involved with this transaction to get a better idea of the net returns.
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Disclosure: I am/we are long QCOM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.