ELF Beauty was Friday's Stock of the Day as it raced past a new buy point. ELF stock is up 85% over the last year, while the S&P 500 has suffered a decline.
Investors searching for yield can generate income on ELF stock by using a covered call strategy.
When selling a covered call, the investor receives a premium and must sell the shares at the strike price if called upon to do so.
One call option contract represents 100 shares, so investors can sell multiple call options if they have a particularly large stock holding.
Elf Stock Trade Has Potential For 49% Annualized Yield
Over time, covered calls can increase returns while also decreasing the volatility of a portfolio.
On ELF stock, a February expiry, 60-strike call option was trading on Friday around $2.95, generating $295 in premium per contract. It would generate an annualized yield of 49%.
ELF does not currently pay a dividend. So generating $2.95 (or $295 for a block of 100 shares) from covered call writing in only one and a half months is quite attractive.
The $2.95 in premium received also gives a small buffer on the downside of about 5%. That means ELF stock could trade about 5% lower between now and Feb. 17, and the covered call trade would still break even.
The break-even price can be calculated by taking the stock purchase price and subtracting the option premium received.
The total capital at risk in the trade would be $5,510. And if ELF stock went to zero, that's how much the trade would lose.
Covered Call Offers Downside Protection
Covered calls are a fantastic way to generate income from a stock holding while also providing some downside protection.
Investors would need to weigh the pros and cons of the stock before initiating a bullish trade like a covered call on ELF stock.
According to the IBD Stock Checkup, ELF stock is ranked No. 1 in its industry group. It has a Composite Rating of 99, an EPS Rating of 91 and a Relative Strength Rating of 99.
ELF Beauty is due to report earnings in early February, so this trade would have exposure to earnings if held to expiration.
Other Option Trades Updated
A short strangle discussed Dec. 20 on Blackstone has achieved a nice profit and can be closed as can an unbalanced condor (in the Dec. 19 column) on Caterpillar. A Dec. 7 long-term trade on United Rentals can be closed for a profit, but a Dec. 29 bearish trade on United Parcel Service was stopped out last week.
Please remember that options are risky, and investors can lose 100% of their investment.
This article on ELF stock is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setup is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
