Lehman Covered Call Trade

Please note, this strategy listed below is for long-term holders of Lehman (LEH) or opportunistic short-term investors who understand the risk associated with this trade.

If you are a long-term shareholder of Lehman and see yourself holding the stock well beyond the recent credit market turmoil, you might want to consider executing a covered call strategy to pick some additional gains in the form of call option premiums. As of the close June 6^th, 2008, the last trade for Lehman Bros. (LEH) was at $32.29. Looking at the 2-year graph, you will notice how the credit crunch impacted the stock in recent months, and it appears that the direction will not change in the short-term.

Knowing you will hold on to LEH common stock through these tough times, you can pick up an extra premium by selling the current June08 $35 Call options are trading for $1.70. Please note, these premiums that you receive are subject to short-term capital gains.

Since I don’t own LEH, I would like to execute a “paper” trade for my mock account by entering a “deep in the money” short-term covered call. Since I will be buying this stock, I would like to increase my safety margin. To do this, I will execute the covered call at $25.

“Paper” Trade Details:

• Buy 2000 shares @ $32.29 for $64,580
• Sell 2000 June 08 $25 call options @ $8.25 for $16,500
• My net cash outlay is $48,080 ($64,580 less $16,500)

As these options will expire on 06/20/2008, I will be engaged in this trade for about 10 days. By selling the $25 call options, I have a safety margin of 22.6% for the next 10 days. There is some risk with this trade because the last time that LEH dropped 22.6% or more in 10 days was at the start of the month.

If this strategy executes at or above $25 per share, my trade should create 2.3% after fees on my net cash outlay. Although 2.3% doesn’t sound that exciting, I am only tying up my cash for approximately 2 weeks. Using a 365 days in a year, my annual percentage rate will be 77.3%. I would also benchmark this performance on an after fee basis against an S&P 500 Buy & Hold strategy…..Please be sure to check back or subscribe to see the results.

Other resources on covered call strategies:

NTRI Covered Call Schnitzel

Optionetics Covered Call Education

Author Disclosure: At the time of posting, I am neither long nor short LEH. This trade is a “paper” trade and is being used for educational purposes.

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