Sequenom Options Entice Investors

Sequenom, Inc. [[SQNM]] has been a beacon of light in an otherwise dark market, but the stock’s options are what’s turning on the bulb for many covered call investors. These investors write – or sell – call options against their existing stock position and collect the option’s premium as profit. The bullish strategy is typically used by long-term investors looking for some extra income, but some opportunities like this one also open the door for active traders.

Sequenom’s $25 February 2009 call options are trading at a premium of $3.90 per contract. This means that investors can sell the right to purchase 100 shares of their stock at $25 in exchange for $390 cash. Investors who purchase the stock right now, at $23.36 per share, can sell the same rights and make a 15.98% return on their investment when the options expire next month. This is a large annualized return, especially given the stock’s bullish performance.

It is important to remember, however, that option premiums are always high for a reason. In this case, Sequenom has clinical trial data that is still not public. Poor results from this data could mean substantial downside for the company’s stock. And any loss in the value of the stock means investors writing covered calls could lose more than the $390 that they gained by establishing the covered call position. However, many investors, including analysts at Soleil, are excited about the potential for the firm’s new drugs.

Investors interested in reducing their risk and leveraging their returns may want to consider establishing a diagonal spread with instead of a covered call. This involves purchasing long-term options, called LEAPS, as a stock substitute, and using them as a basis to sell shorter term options against. Currently, the $15 January 2010 LEAPS calls are trading with an ask price of $13.40 per contract. This means that investors can purchase long-term rights for $1,340 and sell short-term rights for $390 – a 29.1% return.

The amount of money at risk is reduced from $2,320 to $1,340 while the return jumps from 15.98% to 29.1%, but there are many additional risks. For a comprehensive overview of this strategy, check out “A Better Covered Call Alternative” and check out our Tools & Products for more innovative ways to make money with LEAPS options, including our Covered Call Screener software.