A 48% Return — On a Zero-Dividend Stock?
Micron Technology (Nasdaq: MU) manufactures semiconductors, memory chips, flash memory drives and other related products worldwide. Its products are everywhere — in smartphones, solid-state drives, tablets and computers, as well as other industrial and automotive applications.
As you can see in the chart, MU is trending upward quite nicely. The 50-day exponential moving average (EMA) is acting as solid support.
#-ad_banner-#It was recently announced that Greenlight Capital, the hedge fund run by David Einhorn, purchased $1 billion worth of MU shares during the fourth quarter. Greenlight’s year-end investor letter had mentioned the purchase (at $16.49 a share) without giving details about the position size.
Einhorn, who previously shorted the stock, wrote, “A decade of poor results exposed every flaw in the business and killed any love for the stock.” He added, “The sell-side group think has reversed: the mostly bearish analysts now contort themselves to justify earnings estimates that are too low, price targets that are too pessimistic, and stock ratings that are too negative.”
In early January, Micron reported results for the fiscal first quarter of 2014, which ended Nov. 28. Revenue of $4 billion was up 120% compared with a year ago, and earnings per share (EPS) increased 211% year over year.
MU’s price-to-earnings (P/E) ratio of 15.3 is in line with the SPDR S&P 500 (NYSE: SPY), and its price-to-book (P/B) ratio is less than 3.
I am excited about Micron’s upside, but the company does not pay a dividend. However, we can create our own “dividend” with a covered call strategy.
A call option gives the buyer the right but not the obligation to buy shares of the underlying stock at an agreed-upon price (the option’s strike price) within a certain period of time. The seller of a call option (also known as the writer) sells the right to the buyer for a payment known as premium. In doing so, the seller assumes the obligation to deliver the shares at the agreed-upon price should the buyer choose to exercise her or his right.
With MU trading at about $25.40 per share at the time of this writing, we can buy 100 shares and simultaneously sell an April call option with a $25 strike price, which is currently trading for about $1.90 ($190 per contract) and expires April 17. (These calls expire on the Thursday prior to the third Friday of April due to the market being closed for the Good Friday holiday.)
Since we receive $1.90 for selling the call, our net cost is lowered to $23.50 per share. To give us some wiggle room, I like this trade at a net cost of $23.65 or less.
Action to Take –> Here’s how this covered call trade could work out:
If the shares stay above the $25 strike price, the buyer will buy the shares from us at $25, giving us a gain of at least $1.35 per share, or 5.7% in 57 days. This works out to an annual rate of return of 37%.
If MU trades lower, we would not experience a loss unless it falls below our net cost of $23.65 or lower, giving us a cushion of about 7% at current levels.
If MU is below $25 at expiration, then the call option will expire worthless. We then have the ability to sell another call option against the shares to generate more income and lower our cost basis further.
The current price of the option is about 7.5% of the stock’s price. Selling an option for that amount every 57 days would generate income of about 48% a year. Not a bad yield for a stock that doesn’t even pay an actual dividend.
This article was originally published at ProfitableTrading.com:
Generate Up To a 48% Yield on This Non-Dividend-Paying Stock
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