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Recession Proof Covered Call

09/13/2019 9:04 am EST

Focus: OPTIONS

Jay Soloff

Editor, Options Profit Engine

Starbucks covered call options play exploits recession proof growth stock, writes Jay Soloff.

Coffee is one of those consumable goods that you simply don’t want to mess with. The country may fall into a deep recession; the ocean may rise to levels that engulf the coastlines; a meteor at this moment may be hurtling towards Earth; and yet, it won’t stop coffee drinkers from going to buy their next cup of joe.

As an avid coffee drinker, I can certainly appreciate the necessity of a good cup of coffee. There’s even a better than average chance that I’d ignore an alien invasion in order to make sure my coffee supply was in full stock.

Of course, no one capitalizes on people’s love of coffee more than Starbucks (SBUX). The ubiquitous coffee chain now has more than 31,000 stores worldwide. What’s more, the business seems to be nearly recession-proof. The company is one of the few out there which can seemingly continue to raise prices on its drinks without losing sales.

SBUX also does an excellent job of introducing new products to its mix to keep the menu from becoming stagnant. In fact, the company now sells more cold drinks than hot — an interesting trend for a coffee shop.

It’s been a great year for SBUX stock as well, up 40% year-to-date. The stock reached its 52-week high of nearly $100 before recently pulling back to $90. So, what’s next? Is it too late to buy the stock at these levels?

At least one prominent trader believes SBUX has limited upside through October. This trader purchased a large number of covered calls expiring in October with the stock trading at about $90.50.

More specifically, the trader bought 500,000 shares of stock while simultaneously selling 5,000 October 97.5 calls for 37¢. The position collects $185,000 in premium, which works out to about half a percent in yield for the next five weeks.

It may not seem like much but annualized that yield works out to about 5%. Tack that on to the 1.5% dividend yield and you are pulling in a decent income for a growth stock.

Of course, the covered call doesn’t cap the gains on the stock until $97.50, so the position can still generate another $7 in capital appreciation. Overall, this looks like a moderately bullish trade on the stock. Otherwise, if the trader didn’t assume the upside potential was there, the call would have been sold at a closer (to the money) strike to increase yield.

I like trades like this because they add a small yield component to a stock that is generally purchased for its aggressive growth characteristics. And while SBUX customers aren’t directly paying you the yield, it is their business which leads to the company’s growth potential, which gives the upside calls their value.

In other words, by making this trade – which does allow you to participate in some of SBUX’s upside potential – you are essentially getting paid a small income by coffee addicts (like myself)!

Jay Soloff is the Options Portfolio Manager at Investors Alley. He is the editor for Options Profit Engine, an investment advisory bringing you professional options trading strategies, with all the bells and whistles of Wall Street, but simplified so all you have to do is enter the trades with your broker. 

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