Seeking Alpha
Long/short equity, special situations, event-driven, activist investor
Profile| Send Message| ()  

Generating outsized profits from stock trades doesn't have to be a daunting task if you have discipline in your approach. A covered call trade allows you to lock-in profits when a stock rises and generates income for your portfolio when consistently applied over a period of time. Out-of-the-money covered calls are traded on stocks where the target strike price of the call option (and selling price) is higher than the current market price.

United Rentals, Inc. (URI), Walter Energy, Inc. (WLT), Deckers Outdoor Corp. (DECK) and Aruba Networks, Inc. (ARUN) have potentially outsize returns available on their November 2012 call options. In other words, the bid prices on each company's call options show a rich time premium, which can be collected as a profit by holders of the common stock.

By selling the United Rentals, Inc. November 2012 $34 strike price call option against shares you own, you could potentially generate an 8.1% profit, if shares trade above the $34 strike price at expiration. This profit represents an annualized return of 71.5% over the next 41 days. If shares trade below $34, you keep the option premium of $2.50 per share and continue to hold shares of the stock. This time value premium from the sale of the call option is like having portfolio income of 7.8% over a 41-day period. Consistently generating this type of income would represent a 68.7% annualized yield. The breakeven price on this trade is $31.44, or 7.3% below the current price.

(click to enlarge)

Holders of Walter Energy, Inc. common stock could consider selling the November 2012 $32.50 strike price call option for a time value premium of $2.36. If shares trade above $32.50, the investor takes the difference between the current share price of $32.15 and the call strike price of $32.50, as a profit, as well as the option premium of $2.36. This 9% profit over 41 days would represent an annualized return of 78.59%. If shares trade below $32.50 at expiration, the investors continue to hold their shares, but they also receive the $2.36 time value premium of the option, which is portfolio income of 7.8%. The break-even price on the trade is about $29.83.

(click to enlarge)

Deckers Outdoor Corp. November 2012 $37.50 strike price call options can be sold for a time value premium of $2.55. With the common stock trading at $35.97, shares would need to appreciate $1.53 before reaching the strike price. If shares are called, the investor would receive a profit of 12.1% over the next 41 days, or an annualized 106.2%. If shares do not trade above $37.50, the holder of the stock continues to hold their shares and gets to keep the options premium of $2.55. This time value premium on the option boosts portfolio income by 7.5% over 41 days. The break-even price on the trade is $33.46.

(click to enlarge)

The out-of-the-money covered call trade on Aruba Networks, Inc. has a similar outsize return potential. Sellers of the November 2012 $22 strike price call option would receive a profit of 9.9% if shares are called at $22, when their basis is today's price. If shares continue to trade below $22, then the investor receives portfolio income of 6.7% over the next 41 days. The break-even price of the trade is 6.3% below the current price, or $20.02.

(click to enlarge)

The covered call calculations provided above were performed using the Options Industry Council's covered call calculator. Do your own due diligence when investing. Options trading is for seasoned investors with more than a basic knowledge of the market.

Source: Huge Profits From Simple Out-Of-The-Money Covered Calls