VirnetX: Highest Returning Protected Covered Call

Jun. 5.12 | About: VirnetX Holding (VHC)

A protected covered call or collar search performed using PowerOptions tools, seeking to find the highest returning position for companies with a maximum potential loss of 8% and a stock price in an uptrend, produced secure communications company VirnetX Holding (NYSEMKT:VHC) as shown below:

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In a pack somewhat behind VirnetX were networked storage solutions company NetApp (NASDAQ:NTAP) discussed in this article, athletic apparel company Lululemon (NASDAQ:LULU) discussed here, oil and gas drilling company Transocean Offshore (NYSE:RIG) and online professional networking company LinkedIn (NYSE:LNKD) discussed in this article.

A protected covered call may be entered by selling a call option against a purchased or existing stock and using some of the proceeds from selling the call option to purchase a protective put option. The VirnetX protected covered call has a potential return of 3.4% (103% annualized) and a maximum potential loss of 6.3%, so even if the price of VirnetX's stock goes to zero, the maximum potential loss is 6.3% (at expiration).

The highest returning positions as shown above were found by selecting to search and sort by the highest returning positions. Stock prices for companies in an uptrend were found by selecting to include companies with a 100-day moving average greater than the 200-day moving average. The 8% maximum loss parameter was selected, as a loss of 8% or less can typically be recovered fairly quickly using option income generating investment methods.

VirnetX's business model revolves around licensing its intellectual property related to secure communications. The company has secured licensing with Microsoft (NASDAQ:MSFT) and with communications company Aastra Technologies (OTC:AATSF). (VirnetX and Aastra Sign a Patent License Agreement) (Microsoft and VirnetX Settle Patent Infringement Cases)

The company currently has 20 U.S. patents and 26 foreign patents, as well as several U.S. and foreign patent applications.

VirnetX's intellectual property is being used for secure communications related to 4G technology. VirnetX's technology enables secure 4G communications for smartphone and tabular devices (e.g. Apple (NASDAQ:AAPL) iPhone and iPad). The company's Session Initiation Protocol technology was selected by the third-generation partnership project (3GPP) as the primary protocol for 4G Internet communications. VirnetX agreed to license its technology at fair and reasonable nondiscriminatory pricing to users of the technology.

The business models of a couple of other companies come to mind which had a similar business strategy as VirnetX: digital telecommunications company QUALCOMM (NASDAQ:QCOM) and microprocessor intellectual company ARM Holdings (NASDAQ:ARMH). Of course, QUALCOMM did not solely rely on licensing its technology, as is the case with VirnetX, but licensing is/was a large part of the QUALCOMM's success.

Competitors to VirnetX include Cisco (NASDAQ:CSCO) and InterDigital (NASDAQ:IDCC).

VirnetX's stock has been on quite a run over the last two years,with an increase in price of about 600% as shown below:

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VirnetX currently has lawsuits pending with Apple, Cisco , NEC (OTC:NIPNF), Siemens (SI) and Mitel Networks (NASDAQ:MITL) related to its intellectual property. (VirnetX Form 10-Q)

VirnetX appears to be on a good course with it's intellectual property business model, but one negative legal judgment or one negative event related to a breach of the company's technology by hackers, and VirnetX's stock price could take a massive tumble.

An investor seeking to take advantage of VirnetX's rise, but not its fall, might consider the protected covered call listed in the table above. The protected covered call positions an investment for potential profit, yet protects against a large loss. The specific call option to sell is the 2012 Jun 32 at $2.00 and the put option to purchase is the 2012 Jun 29 at $0.95. A profit/loss graph for one contract of the VirnetX protected covered call is shown below:

For a stock price below the $29 strike price of the put option, the value of the protected covered call remains unchanged, even if the price of the stock drops to zero, the maximum potential loss is 6.3% (at expiration). If the price of the stock increases to around the $35 to $40 range, the position can most likely be rolled in order to realize additional potential return.

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