Spice Up Your Wings With Options

Jon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Back when I first started investing, I was terrified of stock options.  Every now and then some advertisement would catch my eye suggesting 90% returns 100% of the time (or some such dribble).  But in the end fear always kept me from pursuing options very far.  I didn't understand options, and as the mob leader from Batman said "you always fear what you don't understand."  A changing point in my investing career was when the Motley Fool began to offer education and newsletter services for options.

Let me say, if you read an advertisement similar to the one described above then you should stay away.  The old adage applies here:  if it sounds too good to be true, then it probably is.  Anybody offering to make you a millionaire overnight is playing the lottery with their strategy.  But there are several approaches to options that are low risk and will supercharge your investment strategy.

Today, I want to show you how writing covered call options can spice up an investment in Buffalo Wild Wings (NASDAQ: BWLD) right now.

Buffalo Wild Wings

I love Buffalo Wild Wings as an investment right now.  In fact, in another article of mine I outlined why I think Buffalo Wild Wings is your cheapest opportunity for major growth.  I won't go into all the reasons why in this article (you can click the link to see my reasoning) but I believe that Wild Wings is here to stay.

As of this writing, the stock is trading for $76.32.  I'm not recommending you act immediately without due diligence and thinking it through, but let's suppose you buy 100 shares at the current price.  Excluding brokerage fees, your investment would be $7,632.   Now let's look at current prices for June 22nd 2013 call options.

As of this writing, an $80 call option is going for $5.60.  This is a phenomenal price for this call.  It implies that their is strong sentiment that Buffalo Wild Wings will continue to rise from its current prices.  Like I've said, I agree with that sentiment.

Let's say that Buffalo Wild Wings stock price goes up to (or beyond) $80/share in the next six months.  When June 22nd comes around, you would have to sell all 100 shares.  This is how your investment would look:

<table> <tbody> <tr> <td> </td> <td><strong>Buy For</strong></td> <td><strong>Sell For</strong></td> <td><strong>Difference</strong></td> <td><strong>Percentage of investment</strong></td> </tr> <tr> <td><strong>Shares</strong></td> <td>$7,632</td> <td>$8,000</td> <td>+$368</td> <td>+4.8%</td> </tr> <tr> <td><strong>Covered Call</strong></td> <td> </td> <td>$560</td> <td>+$560</td> <td>+7.3%</td> </tr> <tr> <td><strong>TOTAL</strong></td> <td> </td> <td> </td> <td><em>+$928</em></td> <td><em>+12.1%</em></td> </tr> </tbody> </table>

This would be a 12.1% return in six months.  It's important to note that if Buffalo Wild Wings never reached the $80/share mark, the option would just expire.  You wouldn't have to sell the stock, but you would still pocket the 7.3% gain.  These are pretty good returns in six months.

Worst case scenario for you is if the share price tanks.  Yes, you will pocket the 7.3% up front, but if shares crash then you would still own the shares and they would be worth less than what you paid.  This presents a problem for people who are day-traders.  But for investors who are buy-and-hold, it not too big of a problem.  Yeah, we all hate to see our stocks go down, but at the same time we are committed to the long haul.  Even if Buffalo Wild Wings was to under-perform over the short-term, I believe it's unreasonable to think that they will under-perform over the long-term.

(The only other downside to the strategy I'm suggesting is taxes.  Your 12.1% gain in six months would be considered short-term gains and be taxed higher)

Not just wild wings

This strategy works with any stock, but when I apply this strategy I'm looking for a couple of things.  

  • Stable Growth/Bright Future
  • Good return for the option contract

Needless to say, some companies have a very bright future, but the options contracts are essentially worthless.  They can sometimes be worth just 1% or lower.  To me, it's not worth locking into a sale at that percentage of return.  In the same way, some companies have great options contracts, but the future is hazy.  Again, I'm not willing to lock myself into a company that could go south any minute.  Doesn't seem worth the risk.

There are several other companies where you can get a return almost as good as Buffalo Wild Wings.  Here's a couple.

Yum! Brands (NYSE: YUM) July 20th 2013 $70 call option:

<table> <tbody> <tr> <td> </td> <td><strong>100 Shares now</strong></td> <td><strong>Sale Value</strong></td> <td><strong>Difference</strong></td> <td><strong>Percentage of investment</strong></td> </tr> <tr> <td><strong>Shares</strong></td> <td>$6,515</td> <td>$7,000</td> <td>+$485</td> <td>7.4% </td> </tr> <tr> <td><strong>Covered Call</strong></td> <td> </td> <td>$221</td> <td>+$221</td> <td>3.4% </td> </tr> <tr> <td><strong>TOTAL</strong></td> <td> </td> <td> </td> <td><em>+$706</em></td> <td><em>10.8% </em></td> </tr> </tbody> </table>

When you look at the growth opportunities that Yum has in front of them including China and emerging markets like South Africa, the future is looking bright to me.  This company meets my requirements for options: bright future; good return for the option.

BJ's Restaurants (NASDAQ: BJRI) July 20th 2013 $35 call option:

<table> <tbody> <tr> <td> </td> <td><strong>100 Share now</strong></td> <td><strong>Sale Value</strong></td> <td><strong>Difference</strong></td> <td><strong>Percentage of investment</strong></td> </tr> <tr> <td><strong>Shares</strong></td> <td>$3,315 </td> <td>$3,500 </td> <td>+$185 </td> <td>5.6% </td> </tr> <tr> <td><strong>Covered Call</strong></td> <td> </td> <td>$210 </td> <td>+$210 </td> <td>6.3% </td> </tr> <tr> <td><strong>TOTAL</strong></td> <td> </td> <td> </td> <td><em>+$395 </em></td> <td><em>11.9% </em></td> </tr> </tbody> </table>

BJ's has been growing at a fast clip, and they've been doing so debt free.  They expect to grow the business by 17 restaurants in 2013, a pretty respectable number for a company with only 130 restaurants currently. This company meets my requirements for options:  bright future; good return for the option.  

eBay (NASDAQ: EBAY) July 20th 2013 $57.50 call option:

<table> <tbody> <tr> <td> </td> <td><strong>100 Shares now</strong></td> <td><strong>Sale Value</strong></td> <td><strong>Difference</strong></td> <td><strong>Percentage of investment</strong></td> </tr> <tr> <td><strong>Shares</strong></td> <td> $5,421</td> <td>$5,750 </td> <td>+$329 </td> <td>6% </td> </tr> <tr> <td><strong>Covered Call</strong></td> <td> </td> <td>$268 </td> <td>+$268 </td> <td>5% </td> </tr> <tr> <td><strong>TOTAL</strong></td> <td> </td> <td> </td> <td><em>+$597 </em></td> <td><em>11% </em></td> </tr> </tbody> </table>

eBay, as you know, is way more than an auction site.  They are also a marketplace.  They also have Paypal, the unofficial online currency.  As Paypal continues to grow, eBay's future continues to impress.  This company meets my requirements for options:  bright future; good return for the option.

The bottom line

All of these scenarios offer a better than 10% return in less than a year.  (Excluding broker fees and taxes) What investor wouldn't want to get those kind of returns?  Options aren't always the right choice as they need to be evaluated with the specific investing scenario and be tailored to your particular investing strategy. But I think that it's clear to see that options, when used responsibly, can supercharge your portfolio. 

thequast has no position in any stocks mentioned. The Motley Fool recommends BJ's Restaurants, Buffalo Wild Wings, and eBay. The Motley Fool owns shares of BJ's Restaurants, Buffalo Wild Wings, and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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