Trade Alert: Sell the Rally
October was the strongest month for the Dow Jones Industrial Average in four years, and while that rally lingers, we’re going to get all we can from it.
Last week we took advantage of it by locking in gains on three of our short put options, and we also collected more income by selling a naked call. Going forward, you can expect more of this same strategy: taking advantage of what the market gives us.
So today we’re going to sell another naked call.
Collect Income From the Upturn
Our opportunity today is from a stock that was formerly under Hewlett-Packard, the tech giant, and has since made a name for itself — Agilent Technologies (NYSE: A).
Agilent Technologies is a medical laboratory and research company headquartered in California, but it has operations throughout the globe. In fact, less than 30% of its revenues come from the U.S.
That means the current strength of the dollar has created currency headwinds for the company to cope with. Eventually the dollar will continue its path lower, making those overseas revenues worth more. But in the meantime, the robust dollar environment is putting pressure on its foreign profits.
For example, although the company announced earnings on August 17 that beat analyst expectations, the stock plummeted more than 10% the following week.
A key reason for the drop was its light guidance, which was impacted by currency headwinds along with a decreased book-to-bill ratio — the revenue it expects to receive but was unable to record on the books.
This falling data point is a bad sign for the modest growth targets the company’s investor community has in its sights: revenue growth of roughly 5% and earnings growth in the double digits.
Since shares stopped falling near the end of September, the stock has managed to rise 15%, but that will be short-lived. Going forward, Agilent will continue to fail expectations, so the recent share-price rally gives us the opportunity to collect income by selling naked calls.
Action to take: Set a Good ‘Til Canceled limit order to sell to open the A February 2016 $40 call option (A160219C00040000) at $1.60. At last glance, it was trading at $1.70. If your order is not filled by Friday’s close, cancel it and I will update you on the trade.
How the Trade Works
Since each contract covers 100 shares, you will collect $170 per contract sold.
In a cash-secured call transaction, in which you keep enough cash in your account to buy and sell that amount of stock, you will need to deposit $4,000 with your broker. This will give you a yield of 4.25% ($170 divided by $4,000) in about three months.
If you use margin, you will need to deposit about $800, a fifth of the full amount, with your broker. This will give you an impressive yield of 21.2% ($160 divided by $800) in about three months.
By selling calls, our risk is that shares rise. That’s why I have picked a stock I believe is poised to fall. If shares are below our $40 strike price by February 19, we will keep the premium we collected and move on to another trade.
We won’t have to worry about our shares being above our strike price on the expiration date, because I will close the position prior to then.
If shares seem like they’re starting to rally, I will close our trade to limit our losses, so pay close attention to your inbox. On the other hand, if the stock moves lower in quick fashion, I will look to lock in the majority of premiums we already collected.
Update on WebMD
WebMD (Nasdaq: WBMD) posted earnings that topped analysts’ expectations today, sending shares up as much as 8%. This is the opposite of what we wanted to see since we sold naked calls on the company last week, but shares will likely drift lower. Since WebMD didn’t change its guidance — it stayed in line with expectations — nothing has shifted my bearish outlook on the company.
The stock remains just below our $45 strike price and our option doesn’t expire until January, so I’m in no hurry to close this position. I expect shares to pull back in the coming weeks, and we should be able to get out with a profit.
Editor, Pure Income