Michael Kors: Highest Returning Protected Covered Call

| About: Michael Kors (KORS)

The stock price for luxury apparel and accessories company Michael Kors (NYSE:KORS) recently took a hit (as shown in the chart below) after fashion lifestyle and accessory product company Fossil (NASDAQ:FOSL) reduced its outlook.

Fossil has a licensing agreement with Michael Kors for marketing Michael Kors' men's and women's timepieces.

Following Fossil's reduction in outlook, the company's stock price took a severe haircut, as shown below.

In a previous article from May 3, 2012, and prior to Fossil's haircut, a protected covered call for the Fossil was considered in order to protect a long position in the company's stock. The Fossil stock is down over 40%, but the protected covered call position outlined in the previous article is only down 5%. An article regarding Fossil will be forthcoming, illustrating how to potentially recover from the 5% loss.

Michael Kors performed well for its first-ever earnings call held on Feb. 14, 2012. The company noted it has had 23 consecutive quarters of comparable sales growth. The company is expanding in Europe and the United States and is starting up operations in Japan. The company had $374 million in revenue in the quarter, which was an increase of 68% in the comparable quarter of the previous year. The company has opened 75 new stores and now has a total of 231 retails stores. The company indicated that department stores such as Macy's (NYSE:M), Dillards (NYSE:DDS), Lord & Taylor, and Bloomingdale's are clamoring for more of the company's products. The company's core customers are in the 30- to 40-year-old range and the company's second tier customers are 18- to 25-year-olds. The company noted that expansion in Europe is more expensive than in the U.S. due to the fragmentation of Europe.

Michael Kors' next earnings call is due in the next few weeks, and with the demise of Fossil's stock price and the companies' close relationship, an investor long in Michael Kors stock might consider protecting their position.

Using PowerOptions tools to perform a protective covered call search for the highest returning positions for profitable companies that have had a pullback in price produced Michael Kors as the highest returning position:

Click to enlarge image.

The search was performed using a maximum potential loss of 8%, as many times a loss of 8% or less can be recovered using option income generating methods. The search included companies with stock prices near the lower Bollinger band, as a pullback in stock price for a company is often followed with the next leg up in price. However, an investor can never know for sure what a company's stock price is going to do, as was observed with Fossil.

A protected covered call can be entered by selling a call option against the stock and using some of the proceeds from selling the call option to purchase a protective put option. The put option protects the position in case the stock price takes a hit. The best part of the protective covered call is the protection is paid for via the sale of the call option.

The highest returning protected covered call listed in the table above has a potential return of 3.9% (43% annualized) and a maximum potential loss of 6.5%. Even if the price of the stock drops to zero, the maximum loss that can be sustained (at expiration) is 6.5%. The specific call option to sell is the 2012 Jun 40 at $3.30 and the put option to purchase is the 2012 36 at $1.60. A profit/loss graph for one contract of the protected covered call is shown below.

For a stock price below the $36 strike price of the put option, the value of the position remains unchanged (at expiration). And if the price of the stock increases to around $45, the position can most likely be rolled in order to realize additional potential return.

As shown by Fossil, an investor should be very protective when a company's earnings release is just around the corner, and Michael Kors' earnings are just around the corner.

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