Fri Jun 16, 2006: Gold Covered Calls (GG, TRE)

The recent sharp correction in the price of gold from above $700 per ounce to below $600 has created some opportunities to buy gold mining stocks at lower prices and sell covered call options on them for relatively high yields.

Two examples are Goldcorp (NYSE-GG, 27.38) and Tanzanian Royalty Exploration (AMEX-TRE, 7.78).

As discussed in previous commentaries, one of the most important factors in successful covered call writing is to purchase stocks with limited downside risk. While there is no guarantee these stocks won't fall further, purchasing now is safer than at recent highs.

The table below highlights in purple the option income available from selling January 30 covered calls on GG at a price of $380 per contract. The unchanged yield, assuming the stock were to close on expiration day January 19th 2007 at the same price it closed today, would be 16.1%, not bad for seven months. If the stock were called away at $30.00 per share the total return would be 27.2% because of the additional stock gain.

Also shown, outlined in blue, is an example of selling TRE calls. As a more speculative stock, it's not surprising that the potential returns are higher. The unchanged yield from selling the January 10 covered calls for $120 each is 18.2% and if the stock were called away at $10.00 per share the total return would be a whopping 52.0%!

Of course if these stocks decline in price over the next six months, covered call writers could end up holding a net loss even with the option income received.

As usual with covered call writing, the income received from selling the calls can be withdrawn from your account and spent immediately, unlike for example C.D. or bond income, which is payable to you only at the end of the interest period. And since in both cases these options don't expire until 2007, short-term capital gain tax on the income might not be due until April 15, 2008. Consult your tax advisor.

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