Option Trading Idea for Baidu, Inc. (BIDU)

06/17/2010 12:01 am EST

Focus: OPTIONS

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:

  1. 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.
  2. 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.
  3. 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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