Try an IBM Buy-Write with a Twist

IBM (NYSE: IBM) is one of the largest stocks in the Dow and one of its best managed. Its earnings report is due April 18, at the start of the May options expiration cycle. We feel IBM has had a very good run up this year (like many other stocks in the Dow), but it still has room to grow. A fair percentage of its earnings are generated overseas, so it's not locked into the U.S. economy. Emerging markets are holding up well and need the consulting and technology that IBM offers. As options trading investors we anticipate IBM to have decent earnings, some of which might already be priced in the stock, so we do not anticipate a huge move up. That is why we recommend a buy-write or covered call strategy, but with a twist. Instead of owning the stock, buy a deep in-the-money call. A deep in-the-money call will act much like the stock, but the initial capital outlay is much lower than buying the stock. In addition, if IBM trades above $150 by the end of April expiration, the buyer here might also benefit from a dividend and perhaps even a dividend increase which some analysts are predicting. If you want to continue to be long the U.S. markets (as we do), there are not many better stock proxy candidates. IBM Buy-Write With a Twist March 28, 2011 Stock IBM Stock/Price $161.80 Next Estimated Earnings April 18 Buy/Strike/Month/Price 1 APR 16, 2011 150C @11.80 Sell/Strike/Month/Price – 1 JUL 16, 2011 165C @ 5.05 Net Cost Price of option – Price of option (11.80x1x100) $1,180 – (5.05x1x100) $505 = $675 Stock Cost Basis Breakeven $161.80 – $5.05 = $156.75 Max Profit (165 Strike + Premium) – Stock Price = Max Profit $170.05-$161.80 = $8.25 Max Loss Price of Stock – Premium Collected $161.80 -$5.05 = $156.75 (if option is exercised) If the option not exercised in April, then max. loss is $11.80 – $5.05 = $6.75 Call Away % Return $8.25/$156.75 = 5.2% return