Fri Aug 31, 2007: ARNA Covered Calls 26%

As explained in this Motley Fool article, Arena Pharmaceuticals (Nasdaq: ARNA, 13.40) is a clinical-stage biopharmaceutical company working on drugs for obesity, insomnia, and other health problems.

Chart of ARNA Stock

Many investors are betting against the company. Recent short interest data according to www.shortsqueeze.com shows that nearly one-quarter of the outstanding float is currently sold short.

Risk is high for owning stock in such a company at this stage in their research. For covered call writers willing to assume that risk, call option premiums can provide a lucrative monthly income.

For example, October 12.50 covered calls are currently bid $350 for each contract covering 100 shares. These options are in the money by $90, so the net time premium income is $260.

The net investment per 100 shares is $1,340 - $350 = $990.

This would be a potential net income of approximately $260 / $990 = 26.3% for seven weeks. These options expire on Friday October 19th, as shown by the option expiration calendar.

The break-even point is $9.90 per share. If the stock declines below this, the $350 total premium income would not be enough to offset the loss from the underlying stock.

But as long as the stock is above $12.50 on October 19th, you can pocket that 26.3% net income as profit.

Until next time, best of luck with your option investments!