Writing In-The-Money Covered Calls To Generate Yield

Includes: ANF, GME, P
by: David Sims

In-the-money call writing against common stock shares can be an excellent way to profit from rich time value premiums in stock options. Some brokers may even allow you to engage in this type of trade in a retirement account, but be sure to understand the complexities of these trades before setting out to execute them.

Companies like Pandora Media, Inc. (NYSE:P), Abercrombie & Fitch Co. (NYSE:ANF), and GameStop Corp. (NYSE:GME). currently have all the necessary components of a great in-the-money covered call trade. Using a calculator provided by the Options Industry Council, we can compute gains and losses on trades that may be available this week.

Holders of Pandora Media common stock may wish to sell the November 2012 strike price $10 call option for a premium of $0.90. If shares continue to trade above the $10 strike price, the shares will automatically be assigned on the expiration date. The seller of the call option would receive the $10 proceeds from the call assignment plus the options premium of $0.90, netting a sale price of $10.90 on shares trading for $10.29 at the close of business on Friday. This would bring the investor a profit of nearly 6% for shares held over 41 days, which is an annualized return of 53.1%. If shares fall below $10, the trade will begin losing money when the price hits $9.43.

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Investors in Abercrombie and Fitch can consider selling the November 2012 $32 strike price call option for $2.59. If shares continue to trade over $32, the shares will automatically be assigned at the expiration in 41 days and this trade would generate a 6.3% profit. On an annualized basis, this profit is 55.1%. If shares fall below the strike price, the investor will receive the option premium of $2.59 and continue to hold their shares. If shares fall below $30.11, the investor begins to lose money on the trade.

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GameStop Corp. common stock holders could consider selling the $23 strike price November 2012 call option at the bid price of $1.35. If shares continue to trade above $23, the stock will automatically be sold and the investor would receive a profit on the trade of 5.6% over 41 days. The break-even price of the trade is $21.77.

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Trading in-the-money covered calls can be a way to boost short-term yields in your portfolio, while limiting downside risk as well. This strategy could be considered moderately bearish, but keep in mind that investors holding common stock are not immune to a full collapse of share value. Selling call options with a high time value premium boosts overall returns, which helps mitigate any possible loss in value from share depreciation.

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