The suggested strategy should be employed only if your outlook on the stock in general is bullish. There are two parts to this strategy and one part entails the selling of a put, which means that there is a chance the shares could be assigned to your account. To implement the suggested strategy you need to own shares in General Electric as we are also going to sell covered calls. If you do not own shares, you can simply put the second part of the strategy into play (selling puts).
The five-year chart below illustrates that General Electric (GE) faces rather stiff resistance in the 21.55-21.80 ranges. Thus, there is a good chance that it could pull back and test the 18.50-19.00 ranges.
The Jan 2013 22.50 calls are trading in the $0.45-0.47 ranges. Sell these calls for 45 cents or better. For each call sold, $45 will be deposited into your account. If your shares are called away, you lock in $2.00 from your shares (based on the current price of 20.50) and 45 cents from the premium you received for a gain of 11.95%. If your shares are not called away your gain is 2%.
The Jan 2013, 19 puts are trading in the 1.00-1.02 ranges. Sell these puts at 1.00 or better. For each contract sold, $100 will be deposited into your account. If the stock does not trade below the strike price, you walk away with gains of 5.25%. If the stock does trade below the strike price you sold the puts at, your entry cost drops to 18.00 (19.00-1.00).
- The best possible outcome in terms of gains would be for the stock to be called away and for the shares not to trade below the strike price you sold the puts at. In this scenario, you walk away with 17.23% in seven months (11.95% + 5.25%).
- Your shares are not called away, and the stock does not trade below the strike price the puts were sold at. In this case, you walk away with 7.25% (2%+5.25).
- Your shares are called away, and the stock trades below the strike price you sold the puts at. In this case, you walk away with 11.95% in gains, and you get back into the stock at 18.00 (19.00 minus the 1 dollar premium you received for the puts).
- Your shares are not called, and the stock trades below the strike price you sold the puts at. In this instance, you get in at a great price of 18.00 (19.00 minus 1.00) but only walk away with 2% in gains. Note this 45 cent premium from the calls sold can be applied to the purchase price to reduce even further from 18.00 to 17.55 per share.
The above strategy is a great way for someone who owns the stock to open up two streams of income, with the added possibility of getting into the stock at a much lower price. Depending on one of the above outcomes, your potential gains could range from a 2% plus a lower entry price to 17.23%. The great thing about this strategy is that you are not taking on undue amount of risk, and you have the possibility of either walking with great short terms gains or the chance to get into this stock at a much lower price. If you are looking to put this strategy to work on lower risk plays, the following article could prove to be of use - Wells Fargo: In At $27.05 Or Get Paid 9.8% In 7 Months.
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Additional disclosure: EPS and Price vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Options tables sourced from money.msn.com.