NaughtyPines

TRADE IDEA: VRX "MONIED" COVERED CALL

NYSE:VRX   VALEANT PHARMACEUTICALS INTL I
2 months ago
Let's start with the metrics for this setup:

Buy shares at 24.54
Sell Nov 18th 22.5 short call
Whole Package/BE/Cost Basis: 20.40 db             per 100 shares/contract (20.40 is also your cost basis and break even)
Max Profit: $210 per 100 shares/contract (if called away at 22.50)
ROC: 10.3%

Now, ordinarily, I like to do "OTM" (i.e., out-of-the money) covered calls where the short call is above the price of the underlying. I feel this gives me a touch more flexibility in working the setup over a substantial period of time should I ultimately decide I want to stay in the play for whatever reason (e.g., continuing high implied volatility, it's ripping to the upside, etc.). Additionally, OTM covered calls offer better ROC %-age metrics, assuming that price continues to move toward your short call.

With a "monied" covered call, you're limiting your upside profit potential from the get-go, although you can naturally attempt to roll the "monied" short call up and out for duration, assuming that you can get a decent credit to do so, which isn't always possible. However, in exchange for "going monied," you're getting a benefit: the stock price can continue to decline somewhat, and you can still make money. For instance, if price is still above the short call strike at expiry, your shares are called away and your profit is the short call strike price (x 100) minus what you paid for the setup -- in this case: $2250 minus $2040. If price is below the short call strike, but still above your cost basis, you still make money; the short call expires worthless (for which you book a profit), but the profit you made from the short call exceeds the price decline of the stock .

As with any covered call, however, you can lose money if price declines below the cost basis of your setup. In that event, I continue to sell calls against my stock , further reducing my cost basis in my shares until I'm able to exit the trade for scratch or a small profit.
2 months ago
Comment: I didn't get filled on this today and didn't have time to do "price discovery"; may try again tomorrow when I've got time to watch price movement around the mid price to see if I can get a decent fill.
LuigiRensinghoff
2 months ago
Earnings Report in 16 days. What are your thoughts about that ? - Will you turn it into an "Earnings Play" on that day ?
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NaughtyPines LuigiRensinghoff
2 months ago
Generally, I play earnings differently. There, I look for volatility contraction, so am more likely to play it as a short duration short strangle or iron condor. You can naturally play both: put on the longer term buy-and-hold covered call here and then play the earnings for volatility contraction separately. But with earnings, I generally look at whether I'm going to do an earnings announcement specific play a few days prior to the announcement to see what I can get out of that play alone ... .
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LuigiRensinghoff NaughtyPines
2 months ago
Well - Thanks - But you did not reply to my question. What are you going to do with this covered call going into earnings ...
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NaughtyPines LuigiRensinghoff
2 months ago
It will depend on how price moves; if it stays above the short call, I would leave the setup alone for the shares to be called away. If price breaks below the short call, but remains above the cost basis for the shares, I would see whether I would want to take it off the entire setup in profit or roll the short call out for duration to reduce my cost in my shares further. If price breaks below my cost basis, I would roll out the short call out for additional duration and credit to reduce my cost basis in my shares. I would continue selling calls against in that manner until I could exit the trade at scratch or in profit.
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