Stock Options To The Rescue! Paychex (PAYX)

| September 27, 2012 | 0 Comments

PAYX OptionsToday we’re looking at an option trade on Paychex (PAYX) to generate some additional income, reduce your cost basis, and profit from the recent decline in the stock.

Here’s what happened…

Paychex shares have fallen 5% from $34.38 to $33.30 after reporting fiscal 1st quarter earnings earlier this week.  They beat Wall Street revenue and earnings estimates as well as reaffirming their full year 2013 guidance.

Here’s the deal…

The leading provider of payroll, human resource, and benefits outsourcing solutions for small- to medium-sized businesses reported a strong quarter.  Quarterly profits rose 2% to 42 cents per share from 41 cents last year.  They beat analyst estimates of 41 cents per share.   

Revenue also grew 3% last quarter to more than $578 million.  Revenue growth was led by a strong performance from its human resource services business.

Here’s the kicker…

The payroll company reported the number of payroll checks per period increased 2% last quarter.  That’s a clear indication that small businesses are hiring more workers.

Don’t forget, small businesses employ half of all private sector employees and generated 65% of new jobs over the last 17 years.  So, it’s great news for the economy.

 Unfortunately, management’s guidance for fiscal 2013 didn’t sit well with investors.  They reaffirmed their earlier guidance but investors were clearly looking for more after the stock’s 37% move to the upside over the last year.

Here’s what to do now…

Let’s assume you invested $3,450 to buy 100 shares of PAYX at $34.50 before earnings.  At this point, you’re down about 3.5% on the trade.  But there’s no reason to panic. 

Remember, PAYX pays a solid dividend.  It currently pays an annual dividend of $1.28.  That’s a 3.86% dividend yield.  And many investors have been attracted to the stock so they can collect those payouts.

At this point, if Paychex merely meets their full year guidance, the stock will have a hard time reaching new highs this year.   Selling the PAYX January 2013 $34 covered call will increase the cash you can generate from holding onto the stock. 

Right now you can sell the January 2013 $34 call for $0.80.  So you collect $80 in option premium as the seller.  And you still own 100 shares PAYX.

There are two possible outcomes for this trade…

First, if PAYX is above the $34 strike price, the option holder will exercise their right to buy your stock at $34 per share.  So your 100 shares will be called away or sold for $3,400.

But that’s just fine… you bought the stock for $3,450.  So you’re realizing a small $50 loss on the sale of the stock.  But you get to keep the $80 in option premium and $64 in dividends.  So your total profits are $94 or a little over 4%.  

However, a more likely scenario is PAYX never reaches $34. 

If PAYX stays below $34 until January options expiration, the option will expire worthless.  You’ll get to keep the $80 in option premium, the $64 in dividends, and you’ll still own the stock. 

You can continue to hold the stock and collect the dividends and participate on any upside.  What’s more, you can sell another call option against your shares and generate even more income.

In my opinion, the recent pullback and lackluster guidance is a perfect opportunity to sell a covered call and increase the amount of income you can generate off of this high yielding dividend stock.

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Good Investing,

Corey Williams

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Category: Stock Options To The Rescue!

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.