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Is NVLS A Covered-Call Candidate?

02/02/11 08:37:19 AM
by Donald W. Pendergast, Jr.

Was last week's tumble in the S&P 500 just a shakeout, or was its subsequent two-day rally a complete fakeout? Who knows, but based on pure momentum, shares of Novellus Systems appear to be offering a near-ideal covered-call setup.

Security:   NVLS
Position:   N/A

Nothing exceeds like excess, apparently, and, in the case of Novellus Systems shares (NVLS), traders and investors don't seem to be able to curb their appetite for the stock. Having risen by more than 270% since November 2008, the stock may now be entering a near-parabolic phase that could still take it to $40 or even higher before finally correcting. Here's a brief look, using the weekly chart for NVLS (Figure 1).

FIGURE 1: NVLS, WEEKLY. Covered-call setups are pretty simple -- simply locate the most liquid stocks that have extraordinary, rapidly increasing upward momentum and which also offer attractive rates of return for near-term covered-call plays. NVLS appears to easily qualify in all of these regards.
Graphic provided by: MetaStock.
This stock is in extreme bullish mode, and to attempt to call a top would likely result in a loss of both trading capital and credibility, should the stock keep on chugging higher. The trendlines have begun to accelerate and climb, the stock has excellent relative strength and momentum versus its peers in the Standard & Poor's 500, and its annualized rate of return on a near-term, at-the-money covered-call setup looks almost too good to pass up.

Here are the details:

* Buy one NVLS March 2011 $38 covered call for $36.50 or less

* Annualized return if stock called away (shares expire in-the-money): 31.44% before commissions.

* Days until March equity options expiration: 44

If NVLS can maintain enough momentum to close in-the-money on March 18, 2011, the holders of such a covered call will have their shares called away and will be able to walk away with a reasonably good profit for their investment of time and trading capital. However, should the stock begin to fall in price, a wise trader will definitely want to have an exit strategy in place to help minimize losses.

Depending on the amount of time until expiration, it usually pays to give a buy-write trade like this a little more breathing room than a typical swing trade in a stock. Moving averages and trendlines can each be especially helpful in this regard; in Figure 1, you see the uptrend line is very strong and is still fairly close to the current price of the stock. A sudden selloff that brings a weekly close below the trendline would be proof-positive that the trade should be closed at and the trading capital set aside for a more promising opportunity.

Conversely, the same trendline can also be used as a kind of trailing stop, should prices continue to rise. At the very least, the use of a hard stop like this should help give traders an extra shot of confidence, should they decide to actually take this trade.

I'm not aware of any mechanical trading systems for covered calls, but apparently you can use the thinkBack analyzer in Thinkorswim to help determine how various covered calls (and just about any other kind of option trade) would have played out after initial purchase. A useful tool indeed. See Figure 2.

FIGURE 2: ORDER ENTRY SCREEN. The order entry screens in the Thinkorswim platform make options trading a very simple process.
Graphic provided by: Thinkorswim.
Until the broad US markets actually confirm it with more downside selling, for the moment, we must assume that the massive uptrend in NVLS (and its brethren in the S&P 500) is still in force. And this covered-call play looks like one of the better, lower-risk ways to take advantage of it.

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:

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