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AROON


Hartford Financial Services Enjoys Steady Upward Momentum

09/16/09 08:51:59 AM
by Donald W. Pendergast, Jr.

One of the highest relative strength component stocks in the S&P 500, Hartford Financial Services appears to be offering a high-yield, low-risk covered call opportunity.

Security:   HIG
Position:   Buy

Hartford Financial Services (HIG) saw its common stock fall by nearly 97% between May 2007 and March 2009. Caught in the center of the financial sector meltdown, it's doubtful that anyone but the most long-term optimist would have believed that a substantial turnaround in the company's share price would occur anytime soon after the meltdown. But here we are, a full six months after the historic market reversal of March 6-9, 2009, and HIG is now above $25 per share, looking as if it still has plenty more steam to propel it even higher. The weekly chart of HIG (Figure 1) will help us determine if a conservative trend-following strategy is appropriate.

FIGURE 1: HIG, WEEKLY. A strong weekly uptrend, one likely to carry through until option expiration, should always be the first criterion to look for when writing covered calls on stocks.
Graphic provided by: MetaStock.
Graphic provided by: CS Scientific Inc. - expert from MetaStock.
 
One of the most effective MetaStock templates for covered call trades is right here before your eyes; it's a weekly chart overlaid with the Metastock CS Scientific expert advisor, a 10-week exponential moving average (EMA) and the Aroon (14) trend intensity indicator. When all three indicators jive together (especially when the broad market is trending higher), it usually means that initiating a covered call trade is a low-risk opportunity. And that's exactly what we see here; the stock is above its 10-week EMA, the CS Scientific advisor has printed a "+L+" (meaning "long") in the gray ribbon at the bottom of the chart and the Aroon (14) has just snapped back up toward its upper limit. The odds are that this stock has enough momentum to carry it somewhat higher between now and the October options expiration, a mere 23 trading sessions from now, on October 16, 2009. Toward that end, let's examine a few of the October calls available for HIG, choosing the most appropriate one for our needs.

FIGURE 2: OCTOBER 2009 CALL. The October 2009 $25 call has excellent open interest, a close bid-ask spread, and offers a good rate of return in a covered call context.
Graphic provided by: ThinkorSwim HIG call prices.
 
Figure 2 is a basic look at four of the call options that might work for a short-term HIG covered call play; the highest open interest (OI) resides at the $25 strike price, but all of the other strikes (the $23, $24, and $26 calls) all have sufficient OI to get the job done. You'll also see that these October HIG calls all feature a close bid-ask spread (with the $24 call having the absolute closest spread). So far, so good; we now look at the anticipated annualized return for each covered call trade (this assumes that the stock is called away at October options expiration). In this case, we see that the top honors go to the $25 covered call, coming in at about an 86% annualized return.

Trade management is easy, thanks to the natural support/trend characteristics of the rising 10-week EMA; a weekly close of the stock below the EMA means that the stock is sold and the short option is bought back, no questions asked (better to get out at the first whiff of a major market reversal and ask questions later). However, if the stock stays above the EMA, just hold the entire position until option expiration. The $25 call will lose a greater percentage of its time value than any of the other calls because it contains the highest amount of time value (a unique attribute of any at-the-money call or put), and all the more so during the last 30 calendar days of the option's life. That's likely the best option to sell, all else being equal.

In the outside chance that HIG fails to stop out and/or fails to expire in-the-money, you get to keep the shares along with the entire short option premium, and, if you desire, you could even sell another call option against the shares. All told, this looks like a very attractive stock/option combo play for conservative investors/traders.



Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address: lineartradingsys@gmail.com

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Date: 09/17/09Rank: 2Comment: 
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