After splitting ten for one on May 12, shares of Baidu Inc. (BIDU) spent weeks bouncing around $70. During the last four trading days, the shares have closed above $72. September implied volatility is around 53%, compared to a realized volatility of 50% for the past six months. For investors who think the stock may rally a little, but will most likely be above $70 at September options expiration, here is a covered call strategy often referred to as a “buy-write.”
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BIDU Covered Call Trade Details
BIDU gained more than 1% to $76.47 during morning trading on Wednesday. Be sure to adjust the strategy prices below to current market pricing.
Covered Call:
Sell the September 80 call for $6.50 per contract (or better)
Buy 100 shares of stock for every sold call (current price for 100 shares is $7,647)
Stock trader? Trade BIDU for a flat rate of $2.95 (flat rate stock trades at OptionsHouse)
Profit/Loss Details (at the time of this writing):
Maximum Potential Profit: If assigned, it is $10.03 (the difference between the strike price and the underlying stock price plus the premium collected). Return on risk is approximately 14%
Maximum Risk: $69.97 (the stock price at the time of purchase minus the credit)
Breakeven: $69.97 (the stock price at the time of purchase minus the credit)
This and every covered call has essentially three possibilities:
- The stock can stay flat, leaving the out-of-the-money call to expire worthless. The investor keeps the premium and gains nothing on the purchased shares.
- The stock can decline, at which point the option again expires worthless and the investor keeps the premium but takes a loss on the stock. In scenarios one and two, the covered call outperforms the stock side of the trade.
- If BIDU moves above the 80 strike between now and September options expiration, the call will likely be exercised, capping the stock’s upside.
By the Staff at ONN.tv
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