Like the stock repair strategy, the stock enhancement strategy can be used to significantly enhance the return on a stock investment with no additional cost.
Example 1
In early March, you buy 100 shares of ZZZ at the current price of $58. Target price is $75.
We’re looking at a profit target of (75 – 58) / 58 = 29 percent.
To enhance this strategy:
- Buy 1 Jan 70 call @ $3.70 per share
- Sell 2 Jan 75 calls @ $2.50 per share
This will produce a net credit of (2.50 x 2) – 3.70 = $1.30 per share.
The net holding is:
- A covered call (long 100 shares + short 1 Jan 75 call)
- A bull call spread (long 1 Jan 70 call + short 1 Jan 75 call)
If ZZZ is above $75 in 10 months at the January expiration:
- The stock will be called away for $75, with a (75 – 58) = $17 gain
- The bull call spread will be worth $5 per share
The total gain will be (17 + 5 + 1.30) = $23.30. This is equivalent to the stock price of (58 + 23.30) = $81.30, which is a profit of (81.30 – 58)/58 = 40 percent, compared to the gain in stock price movement of 29 percent.
Example 2
Instead of buying the stock, buy the call. Also buy the bull spread.
Suppose you buy the 1 Jan 40 call for $19.70 per share with a delta of 0.87. You also buy the bull spread with a credit of $1.30 per share.
This call price will likely advance dollar for dollar with the stock price.
The payoff at expiration if the stock price is above $75 will be (75 – 40) – 19.70 + 5 + 1.3 = $21.60 per share.
The P&L from -$19.70 to $21.60 represents a return of 110 percent!