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As we close the books on April and look ahead to a new month, the old Wall Street axiom, "Sell in May and go away" comes to mind. From a statistical perspective, the summer months are some of the worst months to be a buy-and-hold investor because the market typically underperforms during this period.
Thankfully, we're not buy-and-hold investors. Our covered call strategy is adaptable to many different market environments. With my goal of bringing you trades each week that could generate a minimum of 25% to 35% a year, this trading program gives you a chance to make huge returns over a lifetime of trading.
Today, we're going to take a look at an education stock that can help you make 52% a year using our covered call approach.
If you've been paying attention to the for-profit education industry, you know that it's been a very difficult past few years. The financial crisis, along with a weak employment environment and government spending cutbacks, has sparked a perfect storm for this sector.
Basically, for-profit education companies rely on government loans and grants to students in order to keep enrollment high and new students coming through their doors. Most student loans are backed by the federal government because the loans would otherwise be too risky for banks to offer without punitive interest rates.
Education loans have always been popular government programs, because as the population boosts its knowledge, the workforce becomes more productive, strengthening our economy. At least that's the way it's supposed to work…
As unemployment rates picked up over the past few years, more students defaulted on their loans. This meant that the government had to fork out money to cover the losses, which led to some investigations of for-profit education companies.
It seems many of these schools had unethical recruiting practices, and their graduation rates -- along with employment figures for students who did graduate -- were quite disturbing. Long story short, the for-profit education industry took a nosedive as hurdles for loans became tougher and the negative publicity weighed on enrollment.
But after several quarters of transition, and thanks in part to an improving employment picture, education stocks are starting to show some life. Even better, the stocks are rebounding from very low price points.
Last week, ITT Educational Services (NYSE: ESI) traded sharply higher after beating earnings expectations. The earnings beat caused some Wall Street analysts to upgrade the stock, and it looks like institutional investors are finally starting to plow capital back into this cheap and under-owned group.
ESI is in a great spot for a covered call trade. The low share price and bullish rebound under way help to significantly reduce risk. At the same time, the increase in volatility after the earnings announcement has helped to boost the price of the option contracts. This means that we can expect more income from a covered call setup.
Here's how I want us to set up our trade:
-- Buy ESI near $18.30 in 100-share lots-- Sell the ESI June 17.50 Calls (one for every 100 shares purchased) near $2
With this setup, our net cost should be around $16.30. Of course, when we sell the June $17.50 calls, we are obligated to sell our stock at $17.50 on the third Friday in June, provided the stock price is above this level when the calls expire.
Assuming ESI remains above $17.50, we will realize a net profit of $1.20 per share on the trade. This represents a very attractive return of 7.4% over a 52-day period. If we made a similar trade every 52 days, it would add up to 52% a year.
Please let me know what you think of this and the other recent covered call setups. Just send me an email at editors@ProfitableTrading.com and mention the covered call articles.
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