The Best Approach For Your Covered Call Picks
Deciding how to select your covered call picks for the month should not be a difficult process. All you need to do, is bear in mind that with any covered call trade, there are three possible outcomes. Each of these vary in profitablity, so your best notion is to select the strategy that is most likely to make you the most money.
For anyone coming to this page without a background in Covered Calls, it involves purchasing the underlying shares and then selling call option contracts equal to the number of shares purchased. The risk in selling your short call positions is ‘covered’ by the profit that will be made from the underlying shares.
Assuming you’re selling out-of-the-money calls, here are the potential outcomes:
1. The underlying price action has risen and breached your short option strike price – the best scenario.
2. The underlying price action remains somewhere between your share purchase price and your sold (short) option strike price – next best scenario.
3. The underlying price action falls below your original share purchase price – time to consider adjustments.
The reason why option (1) above is the most profitable, is because this is where you not only receive the gain from the appreciation of your share price, but you get to keep the premium received from selling the call options as well. Even if the price of the underlying security goes ‘through the roof’ you may be forced to sell the shares at the call strike price if exercised, but since you already own them, you make the maximum gain for the nature of the trade. The only downside here is that your profit is limited to the difference between the share purchase price and the call option strike price, plus the premium from selling the options.
The second scenario will make you ‘some’ profit, in that your sold calls will expire worthless so you get to keep the premium. Then you need to make the decision whether to keep the shares (which will also be in profit) and write more calls for the next month out.
The third scenario above, means your shares will be losing money, but this will be somewhat offset by the call option premium received. You can usually buy back your out-of-the-money (OTM) calls rather cheaply and sell more at-the-money calls as you near expiration date. You can even consider selling in-the-money calls, providing the premium you receive is greater than the difference between the original purchase price and the ITM strike price. This last option will lower your risk but you will receive less overall income in return.
Having established the above potential outcomes, your best method for choosing your covered call picks will be based on scenario 1.
Covered Call Picks – How to Stack the Odds in Your Favour?
Naturally, you’ll be looking for a security that is in a steady uptrend. Various methods have been suggested for locating these covered call picks, including moving average crossovers in combination with trendlines, subscribing to information services which monitor and rate the fundamentals of stocks, or joining popular option trading clubs such as Market Club and accessing their advanced market scanning and ‘trade triangle’ technology. In fact, Market Club offer a test drive of their complete service for a mere $8.95 for the first 30 days. After that you can quit any time you like. I’ve found their service and prices to be one of the best.
There are some services that will email you suggested covered call picks, but in my opinion, you’re far better off by taking responsibility for your own decisions rather than relying on someone else’s. There’s a certain psychological advantage in having a sense of ownership for your own trading decisions. When you’re just receiving instructions, I know from personal experience that it’s much easier to go into denial when the trade is not working out the way you expected, because you can just make it someone else’s problem.
There are other covered call strategies you can adopt which are not so aggressive and more suited to bear markets, but finding steadily rising securities and writing near month OTM calls will always provide your best covered call picks.