Forestar Group Options Present Opportunity

Forestar Group, Inc. [[FOR]] shares have recovered over the past month, but the real estate firm’s call options may be the real opportunity for profit. Long-term investors who are bullish on Forestar’s prospects may want to consider establishing a covered call position to squeeze some extra profits out of their investment. However, with earnings coming up, is there a less risky way to profit?

Forestar’s $7.50 February 2009 call options are trading at a premium of $1.35 per contract with shares trading at just $7.80 a piece. This means that investors can purchase 100 shares for $780 and immediately resell the rights to those shares for $135, which will net them a 13.49% return on their investment in just about a month’s time.

The risk is that Forestar could fall after its earnings announcement scheduled for February 4th. The real estate business hasn’t exactly been in the best shape, especially for the single-family residential and mixed-community investments that the firm owns. So, is there another way to capitalize on these high options premiums without all the risk?

Long-term options called LEAPS can be used as a substitute for the underlying stock in a covered call. Instead of purchasing 100 shares of Forestar for $780, investors can purchase the rights to 100 shares over the next 218 days at $5.00 for only $450 down. This means that investors can invest just $450, sell the rights for $135, and realize a 30% return on investment.

The risk in this strategy is that Forestar shares fall sharply lower. While there is 30% downside protection by the premium sold, the option’s market is more illiquid and it may be difficult to sell. That’s why it is recommended that investors using this strategy are long-term investors looking to own the stock regardless of where the price goes in the short term.

See “A Better Covered Call Alternative” for more information on this strategy or check out our Tools & Products for more ways to profit from LEAPS.