Lyft Covered Call: One Way To Generate Income Or Protect Recent Gains

Over the past several weeks, we've discussed how investors could consider writing covered calls on their stock holdings. Today, we look at Lyft and provide an example for a covered call.

Such an option strategy could help investors decrease the volatility of their portfolios and offer shareholders some protection against declines in the share price. Readers who are new to options might want to revisit the initial article in the series before reading this post.

Intraday Price: $54.45
52-Week Range: $21.34 - $68.28
Year-to-date Price Change: Up about 9%

Lyft announced Q1 metrics in early May. Revenue came in at $609 million, a decline of 36% from $956 million reached a year ago. COVID-19 meant a substantial decrease in the number of active riders.

Adjusted net loss was $114.1 million, compared with Q1 2020 adjusted net loss of $97.4 million. The company reported $312 million in cash and equivalents at the end of the quarter.

The company expects to reach adjusted EBITDA profitability in the third quarter of 2021 assuming the post-pandemic economic recovery continues.

Given the significant increase in the Lyft share price in the last 12 months, a covered call might be an appropriate strategy for some investors.

For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date at some time in the future.

As we write on Tuesday afternoon, Lyft stock is trading at $54.45. Therefore, for this post, we'll use this price.

A stock option contract on Lyft (or any other stock) is the option to buy (or sell) 100 shares.

Investors who believe there could be some short-term profit-taking soon might use an at-the-money (ATM) or slightly out-of-the-money (OTM) call option. We will use a July 16 expiry 55-strike call option.

This option is OTM, because the strike price ($55) is higher than the current market price of $54.45.

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So, the investor would buy (or already own) 100 shares of Lyft stock at $54.45 and, at the same time, sell a Lyft July 16, 2021, 55.0-strike call option. This option is currently offered at a price (or premium) of $3.68.

An option buyer would have to pay $3.68 X 100 (or $368) in premium to the option seller. This call option will stop trading on Friday, July 16, 2021.

This premium amount belongs to the option writer (seller) no matter what happens in the future, for example, on the day of expiry.

Assuming a trader would now enter this covered call trade at $54.45, at expiration, the maximum return would be $423, i.e., $368 + ($55.0 - $54.45) x 100, excluding trading commissions and costs.

The intrinsic value of the OTM option at the time of buying is $0. Since the current market price is below the strike price, there is no rationale behind exercising the option. If the stock price moves above the strike price (in our case $55.0), the option then becomes in the money, and it is worth exercising.

Instead, this OTM option has extrinsic value, which is also known as time value. In the case of this covered call, the maximum profit that the trader can realize at expiry is (Strike Price - Stock Entry Price) x 100 + Option Premium Received.

In our example, it would be ($55.0 - 54.45) x 100 + 368 = $423

The trader realizes this gain of $423 as long as the price of Lyft stock at expiration remains above the call option's strike price (i.e.: $55.0).

On expiration day, if the stock closes below the strike price, the option would not get exercised, but would instead expire worthless. Then, the stock owner with the covered call position gets to keep the stock and the money (premium) s/he was paid for selling the option.

At expiration, this trade would break even at a Lyft stock price of $50.77, excluding trading commissions and costs.

Another way to think of this break-even price is to subtract the call option premium ($3.68) from the underlying Lyft stock price when we initiated the covered call (i.e.: $54.45).

On July 16, if Lyft stock closes below $50.77, the trade would start losing money within this covered call setup. Therefore, by selling the covered call, the investor has some protection against a potential loss in the case of a decline in the underlying shares. In theory, a stock's price could drop to $0.

As we have noted in earlier articles, such a covered call would limit the upside profit potential. For example, if Lyft stock were to reach a new high for 2021 and close at $70 on July 16, the trader's maximum return would still be $423.

In such a case, the option would be deep ITM and would likely be exercised. There might also be brokerage fees if the stock is called away.

As part of the exit strategy, the trader might also consider rolling this deep ITM call option. In that case, the trader would buy back the $55.0 call before expiry on July 16.

Depending on her/his views and objectives regarding the underlying Lyft stock, s/he could consider initiating another covered call position. In other words, the trader could possibly roll out to an Aug. 20 expiry call with an appropriate strike.

On a final note, a potential investor who does not currently own Lyft stock could also consider selling a cash-secured put option on the stock. We have covered the topic in detail in earlier articles (for example, here).

Such a trade could appeal to investors who want to receive premiums (from put selling) or who want to potentially own Lyft stock for less than its current market price of $54.45 in our example).

So the trader would typically write an OTM Lyft put option and simultaneously set aside enough cash to buy 100 shares of Lyft stock (hence, it is cash-secured).

The Lyft July 16, 2021, 52.50-strike put option is currently offered at a price (or premium) of $2.93.

This premium amount belongs to the option writer (seller) no matter what happens in the future, i.e. until or on the day of expiry.

At expiration on July 16, the maximum return for the seller would be $293, excluding trading commissions and costs. The seller’s maximum gain is this premium amount if Lyft stock closes above the strike price of $52.50. In that case, the option expires worthless.

As our examples show, these options enable investors to put together trades that are not any riskier than owning stocks outright.

Written By: Investing.com