Overstock Options Present Opportunity

Overstock.com, Inc. [[OSTK]] shares are almost as cheap as its products after continuing their drop today. Retail sales data came in lower for a sixth straight month as consumers continued to tighten their spending. However, there is one deal at Overstock that investors may be overlooking – the premiums on their call options. As a result, covered call investors may be able to benefit handsomely.

The $10 February 2009 call options are trading with a premium of $1.35 per contract despite a stock price of just $9.89 per share. This means that investors can purchase 100 shares of stock for $989 and immediately sell the rights to acquire that stock at $10 for $135 – a 13.65% return on investment in just about a month. However, there’s another way investors can profit using long-term options.

Investors worried about Overstock’s future may not want to commit that much capital to a position. Instead, they may want to consider using long-term options called LEAPS as a stock substitute in a covered call write. Currently, the $5 January 2010 LEAPS calls are trading at an ask price of $6.20 per contract. Using this as a substitute would reduce the capital by about a third while jumping the ROI.

The resulting diagonal spread – that is, a covered call with LEAPS – would cost $620 to establish and provide a return on investment of 21.77%. The downside is that investors may be faced stuck holding the options if the price declines or sell at nearly breakeven, since the bid price of $5.10 plus the $1.35 gained barely offsets the $6.20 purchase price (not including commissions).

See “A Better Covered Call Alternative” for more information on this strategy or see our Tools & Products section for more ways to make money using LEAPS.