Stock Option Advisory

Mortgage Lenders & ARMs

In a previous article, “Bears are After the Homebuilders“, the plight of homebuilders was analyzed as a result of increasing interest rates. Mortgage lenders have also been negatively affected by increasing interest rates, however, there may be a silver lining in the case of mortgage lenders.

During the previous few years when interest rates were very low, many homeowners opted to finance with an ARM (Adjustable Rate Mortgage). Generally, ARMs initially have very low interest rates, but over time, the rates may reset or change, and many times as in the present environment, change for the worse, i.e., a mortgage holder’s house payment increases, sometimes substantially.

With the unattractiveness of ARMs as in the current increasing interest rate environment, many ARM holders will refinance into other mortgage instruments, traditional fixed mortgages for example. This means the mortgage lenders will be busy and their stocks should at least stabilize and maybe even appreciate.

Based on this, a covered call investing strategy for mortgage lenders may be in order over the next few months. Using PowerOptions stock options search tool SmartSearchXL to search for covered call investing positions in mortgage lending companies on October 13, 2006 with all stock options expiring November 17, 2006 (November stock options expiration day), the following positions were found:

SmartSearchXL Covered Call Search for October 13
DRL 5.69 (-0.07) DRLKA 06 NOV 5.0 (36) 0.95 16.7 5.5 5.5
CFC 36.41 (-0.02) CFCKG 06 NOV 35.0 (36) 2.40 6.6 2.9 2.9
NEW 40.77 (+0.30) NEWKH 06 NOV 40.0 (36) 2.55 6.3 4.7 4.7
LEND 35.09 (-0.76) QFWKG 06 NOV 35.0 (36) 2.15 6.1 6.3 6.3
IMH 9.89 (+0.18) IMHKB 06 NOV 10.0 (36) 0.35 3.5 3.7 4.8
AHM 34.63 (-0.25) AHMKG 06 NOV 35.0 (36) 1.15 3.3 3.4 4.5
CFC 36.41 (-0.02) CFCKU 06 NOV 37.5 (36) 1.00 2.7 2.8 5.9


Several mortgage lending covered call strategy stock options positions were returned with potential returns ranging from 3% to 6% (not bad for a 36 day investment) and downside protection ranging from 3% to almost 17%.

The search results illustrate the reason the covered call investment strategy is considered conservative, as all of the positions have “downside protection” of at least 2.7% (see “Aggressive Strategy for the Conservative Investor” for more information). The downside protection is the percentage that a stock can decline in value before the position will incur a loss. Downside protection is simply the option premium divided by the stock price. The NEW position is In the Money (ITM); therefore the percent of unchanged in price and the percent if assigned are equal in value.

Out of the money (OTM) calls offer greater upside potential, but require the stock price to appreciate in order to realize the greater returns as in the case of the AHM the second CFC position. OTM calls are often more a play on stock appreciation rather than covered call income and this can be seen by the higher return if assigned and the lower percent downside protection.

PowerOptions provides a free 14-day trial of its service. So join PowerOptions today, and you too can start reaping the benefits of the covered call investment strategy.

PowerOptions provides Internet based tools for analyzing stock options with specific search criteria and for finding potentially lucrative option income. For those seeking to execute a covered call investment strategy for their personal portfolios, PowerOptions provides an Internet based search engine for finding potentially lucrative income producing covered call stock options positions.

[tags] covered call investing, covered call investment strategy, investment strategy, option income, poweroptions, stock options, mortgage lenders, adjustable rate mortgages[/tags]

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