How to make use of the phone call covered technique to buy dip and rip sell on Warren Buffett’s latest purchase at Taiwan Semiconductor (TSM).
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Berkshire Hathaway (BRK.B) revealed last quarter that it had bought a large stake in Taiwan Semiconductor (TSM) Harvest. How big? How about just over 60 million shares for just below $69 a share. This equates to roughly $4.1 billion spent on Berkshire and famed chairman and CEO Warren Buffett.
The news of the November 15 takeover sent TSM shares up greater than 10% on the day. The stock moved from below $73 before the announcement to shut above $80 after the announcement. Since then, Taiwan Semiconductor has moved back barely to the $78 area.
Buying Taiwan Semi stock at the present level means paying a price near the very best TSM price in several months. This can be well above the value Buffett paid for his large stake in the corporate.
Fortunately, the covered call strategy provides a strategy to enter TSM stocks at a reduction near Buffett’s bid price, while preparing to sell the stock within the event of a giant move up.
A covered call trade consists of shopping for 100 underlying shares and concurrently selling 1 call option in exchange for those shares. This is typically called buying and saving since it involves buying a stock and writing a call option.
In effect, you receive a premium on the decision option sold to assist reduce the online cost of the trade and supply hedging against downsides. That’s the nice part.
However, resulting from the much lower initial transaction cost, your profit is restricted to the execution price of the decision sold.
An example of a TSM covered buy strategy can be to purchase shares at current prices ($78.10) and sell the January tender offer for $85 at $8.80 to scale back the fee of buying the shares by the tender sale amount.
The table below shows that selling the TSM John call for $85 reduces the online purchase price by the premium received for selling the decision of $8.80. This gives a net trade cost of $69.30 ($78.10 minus $8.80), providing 11.27% downside protection until break-even.
Of course, there are not any free lunches in trading. Plus is restricted to the strike price of the covered call sold at $85. However, this still leaves a possible profit of $15.70 points up (short strike price of $85 less initial cost of $69.30). This represents 22.66% of the potential trade profit if the stock closes above $85 on the expiration date of January 19, 2024.
This trade actually matches with Warren Buffett’s philosophy of being fearful when others are greedy and greedy when others are fearful. You’re able to buy TSM stock after an 11.27% drop when others would probably be scared. You are also willing to sell TSM at 22.66% when others are more likely to change into greedy.
In addition, TSM provides a solid dividend yield of 1.83% and a low payout ratio of around 25%, which might further increase the general return or lower the danger of covered trades.
Traders can use different phone alerts or expiration months to sell to suit their risk/return profile. Selling lower strike calls would herald an even bigger premium to lower your risk within the trade, however it also lowers your return.
2022 was a difficult 12 months for stocks. The S&P 500 fell 19%, while the NASDAQ 100 fared even worse. Fortunately, my POWR Options program returned over 50%.
Many experts expect tough market conditions in 2023. Investors and traders who wish to hedge against downsides while allowing for realistic upsides should consider an option-based covered buying strategy.
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Tim Biggam
TSM shares closed at $78.07 on Friday, up $2.34 (+3.09%). TSM has gained 4.81% for the reason that starting of the 12 months, in comparison with the S&P 500 index’s gain of 1.48% over the identical period.
About the Author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Chief Options Strategist at ThinkorSwim and three years as Market Maker for First Options in Chicago. He appears frequently on Bloomberg TV and is a weekly contributor to the TD Ameritrade network “Morning Trade Live”. His overriding passion is to make the complex world of options more comprehensible and subsequently more useful to the on a regular basis trader. Tim is the editor RETURN Options Bulletin. Find out more about Tim’s past with links to his latest articles.
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