Royal Gold Shines as a Covered-Call Play

Now that the market has recouped some of its losses over the last couple of
months, it might be easier to find potential covered-call candidates. The
strategy is to buy a stock (or already own the stock) and sell a call option
against the stock position. A covered call is generally used to generate
additional income for a stock position. Another benefit of a covered call is
that it's like buying the stock at a discount because of the credit received
from the short call. Royal Gold (NASDAQ: RGLD ) looks like a splendid candidate.
The company owns and manages interests in precious metals in 14 countries. The
company just had its best quarter since the beginning of 2008 and looks to
hopefully improve on that next quarter. RGLD has been a steady performer over
the last several months with gold prices rising. Over the last week and a half,
the stock has risen about $10. With the market attempting to rally, gold prices
might just take a breather from going higher, which, in turn, might cause gold
companies like RGLD to take a breather or go sideways as well. If that's the
case, selling the call will generate some income if the stock doesn't rise.
The Trade: Buy 100 shares of RGLD at $75.70 and sell October 80 call at $2.75
Cost of the stock: 100 x $76.70 = $7,670 debit Premium received: 100 x $2.75 =
$275 credit Maximum profit: $605 that's $330 ($80 – $76.70 x 100) from the
stock and $275 from the premium received if RGLD finishes at or above $80 at
October expiration. Break-even: If RGLD finishes at $73.95 ($76.70 – $2.75) at
October expiration. Maximum loss: $7,395 if RGLD goes to $0 @ expiration. The
main objective for a covered-call strategy is for the stock to rise up to the
sold call's strike price, which in this case, is $80. The stock moves up the
maximum amount with being called away, and the sold call expires worthless. If
RGLD just zooms past $80 and looks like it's not going to slow down, then the
call that was previously sold (October 80) can be bought back and a higher
strike can be sold to start the covered-call strategy again. This will allow the
stock to remain in the portfolio and also give the position a chance to increase
its return. Remember: no matter how much the stock goes above $80 at expiration,
the maximum profit is capped because of the call that was sold at the 80 strike.
If RGLD does go sideways or drops in price from where the trade was entered,
selling the call option in essence lowered the cost of the stock by $2.75 a
share. The trade now has a lower break-even point. Every trade should have
defined risk and loss parameters in place even if the trader or investor is just
"paper trading."