An Unusual Covered Call Opportunity in ERIC Stock

NASDAQ: ERIC | Telefon AB L.M. Ericsson ADR News, Ratings, and Charts

ERIC – Why buying beaten down stocks like ERIC and selling expensive call options in a covered call trade will outperform with less risk.

The news from February 16 that Ericcson may have paid bribes to Isis in Iraq sent the stock plunging. Shares dropped 40% from the $12.50 level before finally bottoming out around the $7.50 area.

The drop took shares to levels last seen at the beginning of the Covid Crisis. The drop also took ERIC to extremely oversold readings from a technical perspective. 14-day RSI was slammed to under 20. MACD reached the most bearish levels in the past two years. Momentum nearly fell off the chart. Shares were at a massive discount to the 20-day moving average. The technicals, however, have improved greatly over the past few weeks.

Ericsson (ERIC – Rated “B”- Buy) has since recovered some of those big losses and closed Friday at about a dollar off the lows at $8.52. Some big-time player is thinking that ERIC stock has more room to run if the options market is any indication.

Friday saw very heavy unusual call buying in the ERIC April $9 calls. Unusual call buying is characterized by much larger than normal volume that dwarfs the open interest and spikes the implied volatility (or IV). Implied volatility is just another way to say the price of the option.

Over 47,000 contracts traded Friday in the April $9 calls. Compare that to volume on Thursday of just 90 contracts. Certainly, unusual volume.

Thursday Option Montage

Friday Option Montage

These 47,000 contracts were versus just 2,303 open interest. Open interest indicates the total number of option contracts that still open, or still waiting to be closed out. The fact that the volume was over 16 times the size of the open interest is a clear indication it was fresh, new buying.

More importantly, the implied volatility (IV) of the option jumped from under 50 on Thursday before the massive call buying to over 68 after the big-time call buyer stepped in. This means that the price of the option exploded. In fact, IV now stands at the 100th percentile. Option prices have not been this expensive in the past year.

The April $9 calls were up 20 cents even though the stock rose only 6 cents on Friday. It makes no intuitive sense for the calls to rise more than the stock. This sets up ideally for a covered call trade to lean bullishly with the big call buying while capturing some very expensive option premium.

A covered call trade is executed by buying ERIC stock and then simultaneously selling 1 of the April $9 calls for each 100 shares of stock purchased.

The April $9 calls had a delta of 42 based on Friday’s close. This means that the April $9 calls were equivalent to 42 shares of ERIC stock. Buying 100 shares of ERIC stock and then selling 1 of the April $9 calls makes the overall net delta position 58 deltas net long (100 minus 42) or the same as owning 58 share of ERIC stock.

The cost of the trade is the price of the stock bought minus the price of the option sold. ERIC stock closed at $8.45 on Friday and the April $9 calls were trading around 47 cents. The total cost of the trade would have been $8.45 – $0.47 or just under $8.00.

Compare that to the cost of the trade before the big call buying. The cost of the trade based on Thursday’s closing prices would have been $8.39 for the stock and roughly 27 cents for the options. This equals $8.12 for the covered call trade.

So, the bullish covered call trade actually became about 14 cents cheaper even though ERIC stock rose 6 cents. This was because the big call buying made the options prices way more expensive.

The big call buyer had to overpay to put on that big of a trade. We can take advantage by selling those expensive options and then hedging with the stock.

Stocks are generally lower to start the year. The VIX, a measure of S&P 500 implied volatility, is higher on the year. The combination of lower stocks and higher options is a dual benefit to a covered call strategy.

Selling call options versus long stock positions can bring in additional money in the form of richer option premiums. The trade-off is that you give away some of the big upside in exchange for cushioning the downside and lowering your risk.

2022 is shaping up to be a year where overall market gains will likely come in much lower than the previous few years. Adding covered call strategies can help weather the storm and provide for out-performance even if stocks underperform.

POWR Options

What To Do Next?

If you’re looking for the best options trades for today’s market, you should check out our latest presentation How to Trade Options with the POWR Ratings. Here we show you how to consistently find the top options trades, while minimizing risk.

If that appeals to you, and you want to learn more about this powerful new options strategy, then click below to get access to this timely investment presentation now:

How to Trade Options with the POWR Ratings

All the Best!

Tim Biggam

Editor, POWR Options Newsletter

 


ERIC shares closed at $8.45 on Friday, up $0.06 (+0.72%). Year-to-date, ERIC has declined -22.26%, versus a -11.56% rise in the benchmark S&P 500 index during the same period.


About the Author: Tim Biggam


Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network "Morning Trade Live". His overriding passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR Options newsletter. Learn more about Tim's background, along with links to his most recent articles. More...


More Resources for the Stocks in this Article

TickerPOWR RatingIndustry RankRank in Industry
ERICGet RatingGet RatingGet Rating
SPYGet RatingGet RatingGet Rating
Get RatingGet RatingGet Rating

Most Popular Stories on StockNews.com


:  |  News, Ratings, and Charts

Investor Alert: Prepare to Hit New Lows in July

For as brutal as the market has been so far in 2022...it is likely about to get much worse. Why? Because Q2 earnings season is about to roll out and early indications point to a worsening of results that will likely heighten the stock market (SPY) sell off. This is not a problem for those who are properly trading this bear market. If you are unsure what to do, then read on for this vital commentary providing a timely market outlook and bear market trading plan.

:  |  News, Ratings, and Charts

3 Large-Cap REIT Stocks to Add to Your Portfolio

Since growing concerns over a potential recession due to the Fed’s aggressive interest rate hikes could keep the overall stock market highly volatile in the near term, REITs Crown Castle (CCI), Equinix (EQIX), and Weyerhaeuser (WY) could be good additions to your portfolio for generating a steady income stream. Continue reading...

:  |  News, Ratings, and Charts

Stocks to Fall MUCH FURTHER this Bear Market Cycle

Spoiler alert...the bear market is not over. Unfortunately history shows that the S&P 500 (SPY) has much further to fall to squeeze out excess valuation. That is just a natural part of the bear market process that is properly explained in this timely market commentary. More importantly, this commentary provides a strategy on how to profit in the days and weeks ahead as the market finds its way to bottom. Read on below for more...

:  |  News, Ratings, and Charts

2 Buy-Rated Stocks to Pick Up on Dips

The stock market started the second half of the year with gains. Moreover, the U.S. economy might succeed in dodging a recession, while the Fed is expected to reduce rates later this year. Given this backdrop, we think the dip in Buy-rated stocks Coca-Cola (KO) and Procter & Gamble (PG) might be the right opportunity to scoop them up. Read on…

:  |  News, Ratings, and Charts

Stocks to Fall MUCH FURTHER this Bear Market Cycle

Spoiler alert...the bear market is not over. Unfortunately history shows that the S&P 500 (SPY) has much further to fall to squeeze out excess valuation. That is just a natural part of the bear market process that is properly explained in this timely market commentary. More importantly, this commentary provides a strategy on how to profit in the days and weeks ahead as the market finds its way to bottom. Read on below for more...

Read More Stories

More Telefon AB L.M. Ericsson ADR (ERIC) News View All

Event/Date Symbol News Detail Start Price End Price Change POWR Rating
Loading, please wait...
View All ERIC News