This week’s High-Yield Trade of the Week is with Papa John’s (PZZA).
If you’re following our new Facebook page, you saw my alert on Friday: This is a trade I just made in my own retirement portfolio. In short, I bought 100 shares of PZZA at $62.01 per share and simultaneously sold one April 20, 2018 $62.50 call option for $5.57 per share (which generated $557 in income).
We’ll miss out on most of that upside though. That’s the trade-off we’re making whenever we make a high-yield trade: We’re limiting our potential upside in return for guaranteed income. That may not be suitable for everyone, but that’s exactly what I’m looking for in my retirement account.
Since share prices and options premiums are constantly changing, the numbers below are approximate at the time this alert is being published this morning.
Here’s the opportunity we’re looking at as we go to press…
High-Yield Trade of the Week:
Sell the April 20, 2018, $65.00 call on shares of Papa John’s (PZZA)
As we go to press, PZZA is selling for around $63.59 per share and the April 20, 2018 $65.00 calls are going for about $4.95 per share.
Our trade would involve buying 100 shares of PZZA and simultaneously selling one of those calls.
In exchange for that opportunity, the buyer of the option is paying us $4.95 per share (the “premium”).
Because we’re collecting immediate income when we open the trade, we’re lowering our cost basis on the shares we’re buying from $63.59 to $58.64.
In other words, we’re buying the stock at a 7.8% discount to its current price.
That’s what makes this trade safer than simply purchasing shares of the underlying stock the “traditional” way.
With all of this in mind, there are two likely ways our High-Yield Trade of the Week would work out, and they both offer significantly higher income than what we’d collect if we relied on the stock’s dividends alone.
To be conservative, we don’t include any dividends in our calculations for either of the following scenarios. The annualized yields are generated from options premium and applicable capital gains alone. So any dividends collected are just “bonus” that will boost our overall annualized yields even further. Let’s take a closer look at each scenario…
Scenario #1: PZZA stays under $65 by April 20, 2018
If PZZA stays under $65 by April 20, our options contract will expire and we’ll get to keep our 100 shares.
In the process, we’ll receive $495 in income ($4.95 x 100 shares).
That income would be collected instantly, when the trade opens.
Excluding commissions, if “Scenario 1″ plays out, we’d receive a 7.8% yield for selling the covered call ($4.95 / $63.59) in 88 days. That works out to a 32.3% annualized yield.
Scenario #2: PZZA climbs over $65 by April 20, 2018
If PZZA climbs over $65 by April 20, our 100 shares will get sold (“called away”) at $65 per share.
In “Scenario 2” — like “Scenario 1” — we’ll collect an instant $495 in income ($4.95 x 100 shares) when the trade opens. We’ll then collect another $141 in capital gains ($1.41 x 100) when the trade closes because we’ll be buying 100 shares at $63.59 and selling them at $65.00.
In this scenario, excluding any commissions, we’d be looking at a $636 profit.
From a percentage standpoint, this scenario would deliver an instant 7.8% yield for selling the covered call ($4.95 / $63.59) and a 2.2% return from capital gains ($1.41 / $63.59).
At the end of the day, we’d be looking at a 10.0% total return in 88 days, which works out to a 41.5% annualized yield from PZZA.
Here’s how we’d make the trade…
We’d place a “Buy-Write” options order with a Net Debit price of as close to $58.64 ($63.59 – $4.95) as we can get — the lower the better. Options contracts work in 100-share blocks, so we’d have to buy at least 100 shares of Papa John’s (PZZA) for this trade. For every 100 shares we’d buy, we’d “Sell to Open” one options contract using a limit order. Accounting for the $495 in premium we’d collect for selling one contract, that would require a minimum investment of $5,864.
P.S. We’d only make this trade if: 1) we wanted to own the underlying stock anyways 2) we believed it was trading at a reasonable price 3) we were comfortable owning it for the long-haul in case the price drops significantly below our cost basis by expiration and 4) we were comfortable letting it go if shares get called away. To be mindful of position sizing, except in rare cases, the value of this trade wouldn’t exceed 5% of our total portfolio value. In addition, to minimize taxes and tax paperwork, we would most likely make this trade in a retirement account, such as an IRA or 401(k).
Please note: We’re not registered financial advisors and these aren’t specific recommendations for you as an individual. Each of our readers have different financial situations, risk tolerance, goals, time frames, etc. You should also be aware that some of the trade details (specifically stock prices and options premiums) are certain to change from the time we do our research, to the time we publish our article, to the time you’re alerted about it. So please don’t attempt to make this trade yourself without first doing your own due diligence and research.