Last week we previewed Broadcom (AVGO) earnings and detailed a simple call sale for those that were long stock. That call sale was not a hedge at all but with the stock lower it eases the pain a bit for long holders. Now I want to discuss a new overlay that I think makes sense for those long a stock that just fell following an event. The idea here is similar to an over-write but it also provides leverage in case the stock bounces. I’ll be discussing AVGO in particular here but the concept can apply to other stocks obviously.
With AVGO now 244, we again look at the prior highs in the stock, and try to position for a bounce that adds more than $5 in potential leverage, has an effective sale price in the stock at the prior highs, and whose most likely outcome is collecting a small premium sale:
vs 100 shares of existing AVGO (244) Buy the Sept 250/255 1×2 call spread for a .50 credit
- Buy 1 Sept 250 call for 3.30
- Sell 2 Sept 255 calls at 1.90 (3.80 total)
Breakeven on Sept expiration: Losses below in the stock, gains up to 250, but above 250, 2 times leverage in the stock up to 255. Above 255 called away in the stock but at an effective sale price of 260.50. The most likely scenario is simply collecting the .50 in credit from the trade. It can add up to 5.50 in leverage on a move to 255.
Rationale- This is a good strategy for any stock that just got hit but if you think it has a decent chance of a bounce. It plays for a bounce with no risk other than the chance to be called away in the stock (at the prior highs). If the stock goes lower or sideways (or slightly higher) it simply adds .50 in profit as the entire trade expires worthless. If the stock looked like it had a chance to take out the prior highs (unlikely near term) the trade can simply be closed for a profit and maybe converted back to a simple over-write at a higher strike further out.