Shopify is showing excellent relative strength, closing up 5.95% yesterday. Shopify stock doesn't offer a dividend, but by using a covered-call strategy you can effectively create your own. Here's how.
Turning Shopify Stock Into An Income Stock
Shopify stock is up 57% over the last three months vs. the S&P 500's 12% gain. The stock might be due for a pause. If that's the case, it might be nice to still get some income from Shopify stock with a covered call.
Buying 100 shares of SHOP stock cost around $6,450 this morning.
A July 21, 70-strike call option traded around $2.50. That generated $250 in premium per contract.
Remember, as the option seller you have the obligation to sell 100 shares at the strike price. If you don't have the shares, that's called being "naked" and you are on the hook to provide those shares at the current market price or be short the position. If you own the shares already, it's a covered call since you will simply sell shares you already possess.
In this case, selling the call option generates an income of just under 4% in just over one month. That's more than a 40% yield annualized. You've created your own dividend using the income generated from the option premium.
If the stock remains below 70 by expiration, you will still have Shopify shares and you can repeat the strategy again to bring in even more income.
What Are The Risks?
If Shopify stock closes above 70 on the expiration date, the shares will be called away. Consider that an opportunity cost. You could be missing out on gains if SHOP continues higher.
But it's still not a bad scenario. If you bought at a cost of 64.50, the 70 strike price gives you $550 in profit from the stock sale. Plus you also have the $250 premium you collected for a net profit of $800. So that's still more than a 12% return in just over a month, or a 200% return on an annualized basis. Not too bad.
Of course, there is downside risk too. If Shopify stock drops below 62, you'll have wiped out any gains made from selling the call. And since you still own the stock, the losses could continue. But you at least have a some of the losses offset by the premium you brought in.
Covered calls can be an effective strategy for generating income, managing downside risk and reducing the effective purchase price of a stock.
The IBD Ratings
According to IBD Stock Checkup, Shopify stock ranks No. 12 in its group. It has a Composite Rating of 97, an EPS Rating of 60 and a Relative Strength Rating of 97.
Please remember that options are risky, and investors can lose 100% of their investment.
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 setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
