Covered ReneSola Calls: 25% Upside And Managed Risk

| About: ReneSola Ltd. (SOL)

2013 was a great year for me. I anticipated a resurgence in the solar industry in May and rode that resurgence up to (at one point) a 300+% return. I guess I flew too high and the sun eventually melted my wax wings. Some risky naked calls and overexposure to one stock came back to bite me on December 4th when ReneSola (NYSE:SOL) had a very poor earnings release. In fact, the whole solar sector underwent a brief consolidation phase, and I saw my portfolio lose 60% of its value in a week.

I like to think that I handle stress well, but that wasn't a fun period. So, one of my New Year's resolutions was to protect my portfolio better. Solar had a nice bounce on January 2 -- and I took the opportunity to close out my risky naked calls and begin a more conservative strategy. The nice thing about solar stocks is, they're so volatile that options premiums are quite high. With such high premiums, a covered call strategy can provide very high returns while simultaneously providing some good protection for your portfolio.

Disclaimer: Please conduct your own research before any trades. One purpose in writing this article is to allow me to learn from the community; I'm not an expert by any means.

With the covered call strategy, I expect to see a 25% return in seven months; this blows the socks off the market average, but the covered calls also provides "catastrophic coverage" for my portfolio in case another unforeseen event occurs. There is a plethora of risks in the solar sector, including disruptive technology and policy changes. Even the best of us can't predict everything, as I learned a few weeks ago.

Let's work through the numbers for one example of a winning strategy with ReneSola (which happens to have round numbers). SOL is an underappreciated stock that trades at bargain prices, and I expect it to appreciate through 2014. On Thursday, I plan to buy 100 shares of SOL and simultaneously write one call contract. The longest-term contract that is available right now is July 2014 -- that is my focus because it commands the highest premiums. I also focus on "at the money calls" -- i.e. the strike price matches the current price of SOL shares.

SOL stock currently trades around $4 -- let's round up to $4 for simplicity. The premium for July 19th 2014 calls is $1. Since every option contract comprises 100 shares, the total cost for buying the shares and selling the call is $300. If we assume the share price rises (as I expect) and the contract is exercised in July, I will sell the shares for $400. That leaves a tidy 25% profit for me (minus some transaction fees, which I neglect here but I expect them to be in the $10-20 range. The transaction costs can be mitigated by performing more trades simultaneously.

As long as SOL ends above $3 in July, the trade will be profitable. That would be a hefty 25% drop from its price today -- I'm quite confident that SOL won't fall so far again.

To recap:

  • If SOL maintains its present price, at least, through July -- I pocket a 25% return.
  • If SOL tanks a bit, but not worse than 25% through July -- I pocket a bit of profit.
  • If SOL really tanks, even worse than 25%, I will lose something, but my losses are controlled.

Why am I still bullish on ReneSola, although I lost tens of thousands of dollars on it recently? First reason: I'm buying low.

Second reason: I think the worst news was flushed out of the system on December fourth. SOL's improving cash/debt ratio, as well as heavy US market exposure, improved selling prices across the entire industry, and healthy installation growth in 2014, are further reasons to be bullish.

At a higher level -- What power sources can realistically satisfy our growing demand for electricity in the near future? Coal is too dirty and the US is phasing it out. There are too many hurdles for nuclear power to grow much; these hurdles could be overcome, but it won't happen under Harry Reid and Barack Obama. Even if our Washington leadership changes in the 2016 election, it takes years and years for new nuclear plants to work their way through regulatory approval. Natural gas prices are low at the moment, but they fluctuate. That leaves solar power as the most viable solution (in my humble opinion as an electrical and nuclear engineer). Solar module prices are virtually guaranteed to fall. Expect great things from solar power in the next couple of decades.

To me, the ReneSola covered call sounds like a great compromise. I'm quite satisfied with a 25% return in seven months, although my upside potential is capped. The final feature of this strategy, which I like quite a bit, is that I needn't worry about the day-to-day fluctuations in stock prices. Since I am buying the stock and selling the call simultaneously, and working with long-terms options, I'm fairly well insulated from short-term price action.

Here is a table for some other solar covered call trades you may want to consider. I believe that SOL provides the best risk-reward ratio a.t.m., but I'm investing in other covered calls to be more diversified. Any of the three should beat the market.

Good luck in 2014! and I hope to see comments from more options-savvy investors than myself.

Solar Covered Call Ideas - Dec 2, 2014

Covered Call Cost of One Covered Call Period Best-Case Return No losses unless stock falls by...

ReneSola $30 July 19th, 2014 $1 premium

$300 7 months 25% 25%
SunPower (NASDAQ:SPWR) $32 Jan 15th, 2016 $8 premium $2430 24 months 31.6% 25%
First Solar (NASDAQ:FSLR) $55 Jan 15th, 2016 $18 premium $3900 24 months 46.2% 31.6%

Disclosure: I am long SPWR, TAN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I will likely initiate covered calls in SOL and/or FSLR within the next three days.

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