Yesterday I tried something new – selling covered calls in my IRA account. It’s a strategy I’ve been reading about, and pondering, for years. And what better experimental ground than my IRA and this blog!
Ideally this strategy should be employed on safe, dividend paying blue chip stocks. So we’re naturally going off-script in our maiden voyage by selling covered calls on an enterprise software company that IPO’d within the last six months.
Guidewire rocketed quickly after an underpriced initial public offering (originally $12, it went out at $16 or $17). I was fortunate to buy my initial stake in Guidewire at $21.50 (here’s my initial analysis on GWRE).
This is a technology stock with the boring yet beautiful consistency of a utility. Guidewire’s Q3 earnings report was a yawner (in a good way). My initial analysis for Seeking Alpha garnered 14 total comments, while my Q3 earnings wrap did not elicit one!
Guidewire has sleepily settled into a trading range since April:
I have no interest in selling my shares – this is a position I want for the long haul. So I checked out the option prices, and saw that I could sell an October covered call with a strike price at 30 – a price which has been a formidable upper-bound for GWRE since April.
I sold the contract – which expires on October 20 – for $1.30/share. This will bring in a cool additional 5% on my current GWRE position (shares at $26 as I type) in just over two months – an IRR over 24%. And it’s tax-free, thanks to the tax sheltered nature of an IRA. Not bad!
Which means if Guidewire closes above $30 on Oct 20, I would need to sell my shares at $30 (though I would still receive $1.30/share, and benefit in the capital gain up to $30). I’d then look to re-establish my position on the next pullback.
If Guidewire continues to range trade, then I’ll keep my position, and pocket the 5% gain in 75 days.
So the only catastrophe scenario to plan for (which is why blue chips are usually preferred) is the underlying stock price tanking. I would look to sell Guidewire if it broke down below it’s solid support at $22 – I’d hate to do it, but rules are rules when it comes to risk management.
This was a risk that I was exposed to anyway, though, by virtue of being long the stock. The premium from the call would help mitigate over 1/3 of my potential loss from current prices.
New Trade: Sold to Open GWRE 30.00 October Call for $1.30
Target Gain: 5% in 75 days (Aug 7, ’12 to Oct 20, ’12)
If you’re new to covered calls, please remember that you must already own the underlying stock in order to sell a covered call against it. Contracts are in lots of 100, so you would need to own at least 100 shares.