Cree: Highest Potential Return Protected Covered Call

Mar.23.12 | About: Cree, Inc. (CREE)

A protected covered call or collar search performed using PowerOptions tools seeking to find the highest returning position with a maximum potential loss of 8% for profitable companies with a stock price in an up trend produced Cree Research (NASDAQ:CREE), a company involved in the Light Emitting Diode (LED), wireless communications and power electronics market segments, as shown below:

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Following closely behind Cree Research was Riverbed Technologies (NASDAQ:RVBD) which was the top dog in Wednesday's article and Seagate Technology (NASDAQ:STX), the topic of interest in last Friday's article. And, rounding out the bottom of the list is Google (NASDAQ:GOOG) which will most likely be the topic of a future article.

The protected covered call position found for Cree Research has a potential return of 3.6% (43.8% annualized) with a maximum potential loss of 6.8%, even if the price of the stock goes to zero.

The 8% maximum loss search parameter was selected, as a loss of 8% or less can generally be recovered fairly quickly using income generating methods. A protected covered call is an income generating method where a call option is sold against a stock and some of the proceeds from selling the call option are used to purchase a protective put option. The search parameter for Price-to-Earnings (P/E) ratio of greater was zero was used in order to include profitable companies and a 100 day moving average greater than the 200 day moving average was used to include companies with a stock price in an up trend.

In its previous Q2 2012 earnings call presented on January 17, 2012, the company's results were mixed, as revenue associated with LED indoor and outdoor lighting performed well, but business in power and communications were poor due to softness related to solar and Radio Frequency (NYSE:RF) applications. The primary driver in the poor performance for solar related products was due to weakness in solar inverter demand. Additionally, profit margins related to solar and communications products were negatively affected due to lower factory utilization and lower demand.

The company's three priorities for 2012 are to continue to lead the market and drive adoption of LED lighting, to accelerate cost reductions and drive operational improvements and to grow power and communications products beyond niche applications.

With the LED lighting business, Cree is involved in a very large market segment which appears on the cusp of going ballistic. Apparently the stock market realizes this, as in spite of recent mixed results, the company's stock price has continued in an upward trajectory since the last conference call as shown below:

One reason Cree appeared at the top of the search list shown above is due to the company's upcoming earnings release scheduled for April 17, 2012. Companies about to report earnings often experience increased option premiums prior to the earnings release. Cree's 2012 Apr 30 put option has a lot of open interest at 4200 contracts, so it appears some investors think Cree may report poor earnings in April. The company also has 13.1% short interest which also indicates a bearish outlook for the company. Additionally, companies in the solar industry haven't been fairing too well lately. For example, Suntech Power's (NYSE:STP) stock price is currently around $3 and was in the $15 range two years ago. Yet, Home Depot (NYSE:HD) indicated in its most recent Q4 2011 earnings call held on February 21, 2012 that sales of light bulbs have been very strong. The strong sales of light bulbs could be a result of selling lots of LED light bulbs with some of those bulbs having Cree's components. The question is whether Cree's LED light bulb component revenue/profits can make up for a shortfall with respect to its solar product components.

With the cloudiness surrounding Cree's earnings results, the protected covered call shown above could be an attractive investment, as it enables an investor to potentially prosper if Cree announces good results and protects and investor if the company reports poor results. The specific call option to sell is the 2012 Apr 30 at $2.22 and the put option to purchase is the 2012 Apr 27 at $0.77. A profit/loss graph for one contract of the position is shown below:

For a stock price less than the $27 strike of the put option, the value of the protected cover call remains unchanged. If the price of Cree's stock increases to around $35, the position can most likely be rolled in order to realize additional potential income and return.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.