Generate Extra Income Using Covered Calls: Episode 1

Financial crisis and the concept of making money

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investment thesis

I recently wrote about two companies that I excel at, NuScale Power Corporation (SMR) and Photronics, Inc. (PLAB). As I explained in those articles (Photronics here, NuScale here), I am tall both of them. I also wrote covered calls against these situations, and took out the premium as a way to lower my net cost.

NuScale Energy

As I mentioned in my last article on SMR, global demand for clean energy will continue to grow and nuclear energy should be part of most countries’ energy mix, whether for geopolitical energy security or diversification. History has shown that fission reactors have been operated relatively safely and have done far less harm to people and the environment than many people realize.

NuScale has taken the regulatory lead in the underdeveloped area of ​​small reactors by developing scalable power plants that should be easier to site and deploy than previous generation large-scale nuclear reactors. They achieved this by using pressurized light water reactor technologies and existing nuclear fuel. Other companies are developing SMRs based on new and innovative technologies that require more validation and testing due to the unknowns inherent in them.

I’ve owned shares of SMR (which is the SPAC merger partner Spring Valley Acquisition Corp.) since last April. I’ve also written covered calls against positions several times, with the last one expiring out of the funds last Friday, November 18th. The $20 strike call options were sold when the stock was at roughly the same levels as today, or around $10.80. . So I am now evaluating which options to sell again.

I’d like to own this stock for the next 3-5 years, but my near-term outlook for the company takes into account its limited current revenue and long lead time. As indicated in the recent earnings conference call, they are currently executing very well against their business plan and are on track to achieve commencement of operations on their carbon-neutral energy project with UAMPS in 2029, although that plant has also experienced cost overruns and delays. In the past.

List of NuScale milestones for 2022

NuScale 3Q22 earnings presentation

Given that the company has established these milestones and the roadmap, I suspect that even the positive news of signing another customer by the end of the year will have very much of an impact as should be expected and the company has been very transparent about where these efforts are. concentrated. Of course, any negative news regarding the UAMPS project will be very detrimental to the share price.

Given these factors and the risks in owning this early-stage company, I would like to choose a strike price that provides significant upside, so I am looking for out-of-the-money call options. I decided I’d be happy if the stock recovered to its recent highs of $15+ by May 19, 2023. 179 days to expiration is longer than I normally like, but limited volume makes shorter-dated options so illiquid that bull calls have low bids Extremely. If the stock moves above the $15 strike price at expiration, that would still give an additional 39.4% increase to the stock if you allow it to be called. With no profits, you are unlikely to exercise before expiration.

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Data by YCharts

I didn’t pull the trigger on this trade today because the market and SMR stocks are both down, but the $15 call option traded on May 23 at $0.50 ($0.40 bid / $0.65 with an implied volatility of 65.89%), which works out to about 4.64 % of the underlying share price, or 9.47% annually.

Phototronics, Inc.

Another company I covered recently is Photronics (PLAB), a manufacturer of photonics used in the production of semiconductor wafers and flat panel displays.

My thesis is that investors are not giving enough weight to the tailwinds in the photomask market that will likely result in continued tight supply/demand conditions even if there is softness in semiconductor production in general. These tailwinds include a previous lack of investment in equipment to produce masks for the more mature decade, which turned out to be in greater demand than the industry had anticipated. Moreover, there is also a trend of larger numbers of custom chip designs that require new photonics to be produced. As a result, PLAB increases selling prices and negotiates long-term agreements with customers, resulting in the strongest revenue and profit margins in the company’s history. It will take several more years to solve the mask shortage due to the difficulty in obtaining the equipment needed to make more mature knot masks.

I plan to be in this stock for at least three years given these dynamics and its attractive valuation, which I cover more fully in the above article. The stock’s volume is also limited, and in recent quarters it’s had strong post-earnings moves in both directions. The company is expected to report its year-end earnings on Oct 31, 2022 in the next two weeks, so the Dec 16’22 options have higher implied volatility and prices. Normally, I would look to collect at least 1% of the value of the underlying stock in selling a short call, which would be at least $0.19 in this case. Again, I would try to wait for a bull day for a better result, but the current $22.50 strike in December finally traded at $0.22 ($0.20 bid/$0.25 ask, 62.87% implied volatility).

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Data by YCharts

PLAB’s management gave guidance for the fourth quarter that disappointed some investors, but the stock has bounced back from those lows. As has been pointed out in the past, guidance tends to be conservative. I’m also anxious to see what management will do with the company’s growing cash balance. I think the strong report could push the stock higher through the $22.50 strike price.

If trading at a significantly higher level, I would have to evaluate whether I wanted to roll my calls into a higher and longer strike price or let the stock call away and wait for another entry point. Assuming I get $0.22 selling the calls, that’s 1.17% of the current share price, but with only 25 days expiration is an annualized return of 17.2%. Furthermore, the $22.50 strike price is 20.5% higher than the price the stock closed at today.

Takeaway

In this article, I relate two of my recent research reports to my prevailing strategy of writing covered calls against my business to generate enhanced returns.

Covered calls reduce the net cost of an investment strategy. Beyond that, however, they do not offer downside protection. Therefore, I carefully research the underlying companies and maintain the discipline of only doing buy/write on companies I feel comfortable having in my portfolio.

Please note that the annual returns shown above are indicative only. Options prices change with many factors affecting their implied volatility. I cannot predict how market forces or specific stocks will affect the amount of premium I will be able to collect in the future on these investments.