Bed, Bath and Buy-Write Beyond – Bed Bath & Beyond Inc. (NASDAQ:BBBY)
It’s been a tough go for traditional retailers, thanks largely to the continuing growth of online shopping. That said, the increased volatility in the stocks provides opportunities for investors to generate high income from buy-write strategies (also known as covered calls).
Covered-call writing, or buying shares and selling call options against them, works best on beaten-down stocks for investors willing to own them at a discount to the already-reduced levels. While the strategy can generate considerable income, investors must understand that it lacks the principal protection of traditional income strategies, so comfort with becoming a shareholder is essential.
The advantage in doing buy-writes on beaten-down shares is twofold. Not only do you position yourself to own stock at historically attractive prices, but the options you sell to generate income often carry more premium, relative to the stock price, than they would if the stock had been performing better. Put another way, volatility tends to rise as stocks fall, and this gets reflected in increased option prices. It’s a little bit like the market paying up to shut the door after the horse is already out of the barn.
Because earnings releases are the most predictable sources of short-term volatility, it’s usually best to write (sell) options that expire before a company’s next scheduled announcement. One can never predict interim events, of course: this simply manages risk that you can control.
Back to retail. Consider Bed Bath & Beyond Inc. (NASDAQ:BBBY). The stock is down from nearly $70 a year ago to the low $40’s now. The company reported earnings two weeks ago and won’t report again until the fall. Accordingly, we have a good setup for a buy-write using options expiring in mid-August.
With shares currently trading around $43.10, a buy-write using the calls struck at $42.50 and expiring on August 19th looks attractive. The bid side in the calls is $2.03, meaning that an investor’s net cost is $41.07. Assuming the stock remains above the $42.50 exercise price, the investor will earn a return of 3.48% for a trade that takes just over six weeks. Annualized, this return becomes 28.49%. Not bad in a zero-rate world. Again, this means the investor has to be willing to own shares at $41.07 if the stock is below $42.50 at expiration. But that may not be a bad outcome, considering that the 52-week low close, reached on post-Brexit Monday, is $41.86.