It’s the middle of February and it’s almost time to start thinking about spring. In particular, with spring comes spring cleaning … and now may be a good time to spruce up your portfolio by clearing out the old trades that aren’t doing much for you and adding new ones that will set you up for your next season of profits. And so today, here is a covered call trade idea that might make your account shine.
Defense contracting giant Lockheed Martin (NYSE:LMT) just reported earnings, and the consensus was generally good — even on mixed results. Quarterly net sales were slightly short of expectations, but fourth-quarter operating earnings of $2.53 a share toppled last year’s $2.28 a share.
LMT has been ebbing and flowing over the last six months and has slowly crept higher. And over the last month or so, 12 analysts have raised their forecast for 2012, with only two lowering their forecast.
Just recently, LMT hit its 52-week high and has continued to move higher. Here at $88 and change, the stock has room to head higher to its next resistance level in the $98 area, which was formed back in 2008.
However, the stock may be a little extended and could pull back before marching higher. And that is a great setup to establish a covered call trade, to collect option income while the stock gradually makes its way higher. Specifically, selling an out-of-the-money $90-strike call will give the stock some room to head higher … and pay you for your patience in the meantime.
Making the LMT Covered Call Trade
With LMT trading at $88.45, you could…
Example: Buy 100 shares of LMT @ $88.45 and sell the LMT March 90 Call @ 70 cents
Cost of the stock: 100 X 88.45 = $8,845 debit
Premium received: 100 X 70 cents = $70 credit
Maximum profit: $225 — that’s $155 ($90 – $88.45 X 100) from the stock and $70 from the premium received if LMT finishes at or above $90 @ March expiration.
Breakeven: If LMT finishes at $87.75 ($88.45 – 70 cents) @ March expiration.
Maximum loss: $8,775 which occurs in the unlikely event that LMT goes to $0 @ March expiration.
Managing the LMT Covered Call Trade
As in most cases, the main objective for a covered call strategy is for the stock to rise up to the sold call’s strike price at expiration, which in this case is $90. The stock moves up the maximum amount without being called away (sold call expires worthless) and a profit is made on the shares.
In the event LMT continues to move up and past the $90 area, which is the strike that was sold, and it looks like it will go much higher, then the call that was previously sold (March $90) can be bought back and a higher strike can be sold against the position to avoid assignment. This allows the stock to remain in the account and also give the position a chance to increase its return.
If the stock drops in price more than was anticipated (based on a stop-loss), it might make sense to close out the entire trade (stock and short call) to avoid further losses.
