Thinking About the PALM Covered Call

My PALM covered call, which I opened on Jan. 20, has moved below the point of profitability. So, what to do now?

The February options are 24 days away from the last day of trading before expiration, and the stock has 2-1/2 or 3 percent to go before it hits the next support point.

The position was structured as follows. Shares of PALM bought at $12.63, and the FEB 13 call option sold for an 83 cent credit. (The FEB 13 means the options expires in February and has a strike price of $13.) . . .

The combined position is profitable if the stock is trading above $11.80 ($12.63 - $0.83). Shares are now selling at $11.34. (The discussion ignores the effect of trading fees.) If PALM is above $13 at expiration, then the option is exercised and I'm obligated to sell the shares for $13, no matter how high the current price is on the market. Both the shares and the option go away from my account. If PALM is below $13, then the option expires, I keep the stock and life becomes more complicated.

In the second case, I need to decide whether to close the position early to forestall further losses as the stock declines, or to retain the position through expiration, holding on to the stock in the expectation that it will rise.

I can buy the FEB 13 call now for 26 cents, and sell the stock for $11.34. So closing the position today would give me $11.08 ($11.34 minus $0.26). The position cost me $11.80 to enter, so I would lose 72 cents on the deal.

If I had done the minimum position -- 100 shares of stock and 1 call option -- then I would be down $72.

If the stock rises back above $11.80, then I'm profitable again, and I have 3-1/2 weeks in which that could happen. Next resistance on the upside is around $11.80, or 4 percent away from where I am now. The risk expecation is skewed slightly to the downside,  about 1.5 percentage points.

However, if the option expires and I continue to hold the stock, then I get to keep my 83 cent premium on the options.

If the stock rises near enough to $13 again to provide sufficient option premium, then I can sell another covered call. If the stock continues to fall, then I can sell covered calls below $13 (at the risk of taking a loss on the stock if the call is exercised).

The problem with continuing to hold the stock is that I end up with a zombie position, the living dead lurking on my account and tying up funds. PALM pays no dividend. So, it's of little use unless I sell covered calls for income.

I don't intend to trade out today. If shares move below $10, then that's a break through major support, and I might close. Or I might keep the zombie, because I think PALM is a sound company for the longer hall.

I have a zombie, MCO, that has been on my account since May 2009, the remant of a covered call position. I bought it at $29.85, earned $1.96 from selling the call, for a basis of $27.89.

MCO fell to a low of $22.56 in November, subsequently rose to $27.97 on Jan. 20, and has fallen to $26.40.

I intend to hang on to the position, which is trending upward-ish again, until it nears $30, and then sell another $30-strike call against it.

Sometimes, patience can be a good thing in the markets. It helps that MCO pays a dividend, so I've been making money even after the stock went zombie.




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