Timing Cisco's Covered Calls - TheStreet

Timing Cisco's Covered Calls

Is it the right time to write 'em? Sometimes the best trades are those not made.
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Given

Cisco's

(CSCO) - Get Report

impressive gains Wednesday (and the past few months), we wondered whether it's the right time to write what are known as covered calls on Cisco.

Or whether it's the right time to do nothing.

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Message Boards.

That's right. Sometimes, as fund manager Jordan Kahn of

Kahn Asset Management

explained, it's best not to sell away your potential upside in a sparkling stock like Cisco.

"How many times, how many times I have sold Cisco and then wished I hadn't?" asked Kahn from his fund's offices in Santa Monica, Calif. (By the way, he is currently long Cisco.) The stock was up 5 3/16 to 131 after

Credit Suisse First Boston

pegged Cisco as the first soon-to-be trillion-dollar market-capitalization company.

Either way, does that mean it's the right time to sell call options on Cisco? Covered-call writing is a strategy used to pad returns, and selling calls allows you to take in some extra dough while you hold the underlying stock. But sellers are also obligated to give up their shares to fulfill their end of the options contract, and that could mean the investors sells out of a position that has significant upside remaining. They can also buy the contracts back to cover, but that's often an expensive proposition.

Covered calls are better with a big, liquid stock like Cisco and are especially attractive if you bought the stock way back when -- say, at 30 a share. Remember, selling covered calls on Cisco is vastly different from selling calls on

VerticalNet

(VERT)

, a volatile tech stock public for barely a year (we pick it at random).

That kind of stock can whip around and boast thunderstorm volatility; Cisco, on the other hand, is more predictable and tends to move lower usually only with its sector.

The key, Kahn said, is the short- and long-term outlook for Cisco stock. "What are the objectives? If you think it's going to stay flat or drift after this wave of good news, then by all means, sell covered calls." Your outlook should be flat to slightly down for the stock price if you want to sell calls.

He recommended selling Cisco March 130 calls, which are short-term options that let the investor take in premium and that expire fairly quickly. The hope is that Cisco lands somewhere under 130 on the third Friday of March.

Or, if the stock moves higher, then an investor could buy back, say, half of the calls and have the stock called away on the remainder.

"By doing that, you leave yourself open to buying back some of the call options close to expiration without taking on too much risk," he said. "If the stock keeps moving up, your loss on the options is offset by your gains in Cisco stock" you still hold.

So, let's say you sold Cisco's March 130 calls, fetching about 9 ($900 per contract). You take in a $9 premium, but you've just sold away the stock's potential upside. Your break-even point would be when Cisco stock hits 139. If you think it's unlikely the stock will hit 139 by March expiration, then it's a good idea, Kahn explained, and you could even repeat the whole song and dance with covered calls again for April.

Or, if Cisco raises the roof and zooms up by March expiration, you have to be prepared to have your stock called away or to buy back a portion of those calls.

"Let's say you sold those March 130 calls and Cisco's at 145 by expiration. You've sold those at 9 and now buy them back at 15," he said. "Yeah, you lost money on the calls, but it was offset by gains on the underlying Cisco stock."

Then there's the do-nothing strategy.

"If you think Cisco's going to just keep going slowly upward, it's better to do nothing. A long upward ascent in a stock is better than anything in the world," Kahn sighed.

Back in the pits, we noticed some more unusual option activity cooking in

Rare Medium

(RRRR)

, highlighted a few months ago in this

column.

Back then, it was the May 12 1/2 puts stirring the pot, and they were fetching 2 3/8 ($237.50) with the stock at 16 1/2. Wednesday, said May 12 1/2 puts were selling for 1 ($100), but the more active were the February 45 puts, down 1/2 ($50) to 2 ($200).

The stock was lately down 3/16 to 46 9/16.

More heat-seeking activity was happening in

Globo Cabo

(GLCBY)

since

Monday, this time in the March 17 1/2 and 22 1/2 puts, which were trading 1,000 contracts each. The puts were selling for 5/8 ($62.50) and 2 5/16 ($231.25), respectively, while the stock was down 1/16 to 24.