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Covered-Calls 101

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A "Bear" Market Indeed!

Another week of losses in the broader equity markets has put extreme downward pressure on portfolio issues Calgon Carbon (NYSE:CCC) and Premier Global Services (NYSE:PGI), but neither position is ready to close just yet.

The adjusted basis in the CCC covered call is near $14.15 for traders who rolled down and forward to the JUL-$15.00 strike and the current trading range should find price support no lower than $14.00 as long as the company's fundamental outlook does not change. A move below that price (on a closing basis) would signal an exit in the position for all but the most optimistic investors.

The technical condition of PGI is less impressive in the short-term but again, an area of historic buying pressure exists slightly below the cost basis (approximately $13.50, given Monday's "gap down" to $14.60 at the opening bell) of the position. The first sign of complete technical failure -- and our catalyst for an early exit from the current covered-call position -- would be a closing price below $13 on increasing volume.

Remember, closing a covered-call position involves buying the call(s) and selling the underlying shares of stock, thus a net-credit order can be used to execute the trades simultaneously, without undue slippage. For those who are more adept at timing market swings, one or the other transaction can be initiated first (repurchase sold calls OR sell stock, depending on directional momentum) but be aware of the potential for additional losses if the share value does not move as expected or the closing order is not executed in a timely manner.

New Position

We decided to look for a short-term hedge play in this week's portfolio and based on the way gold stocks are performing, it appears that Kinross Gold (NYSE:KGC) is a good candidate to offset further downside activity in the broader market sectors. Gold is currently trading near all-time highs and the technical outlook for KGC reflects unlimited upside potential with near-term support in the $22-$24 range.

Buy KGC Stock: Last Price = $26.84
Sell APR-22.50 Call (KGC-DX): Bid Price = $4.80
Cost Basis = $26.84 - $4.80 = $22.04
Downside Protection = 17.9%
Maximum Profit = 2.1% (without margin)

The target entry price in this example trade will be:

Net Debit = $21.85
Downside Protection = 18.6%
Maximum Profit = 2.9% (without margin)

Please understand, this a hedge for our current positions as the stock will likely move in opposition to broad equity index values (and it will certainly trend lower if gold prices fade). Based on your current holdings, it may or may NOT be an appropriate candidate. We'll monitor the position in the coming week to determine if an entry is possible. A stop-loss transaction (or position adjustment) should be initiated if KGC's share price closes below $23.25 - $24.00, depending on each individual investor's risk versus reward tolerance.

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