Writing covered call options is a stock market strategy for gaining income. If you own 100 shares of stock, you can write (“sell”) an option giving the right to someone to buy those shares from you at a preset price (the “strike” price) on or before a preset date (the “expiration” date). For selling this right, you receive cash (a “premium”). The strike price would be higher than the price you paid for the stock, so if that option is “exercised,” you will make money for selling the call and on the sale of the stock.
Because stock prices change daily (sometimes hourly), it is imprecise to name specific stocks that make good covered call candidates. Instead, we will examine the characteristics of stocks that will make them good potential stocks to write covered calls against.
Neutral To Bullish
The strategy of writing covered calls works best on stocks on which you are neutral to slightly bullish. Unlike an investor who simply buys a stock and doesn’t make any money unless the stock price rises, covered call writers make money if the stock goes up or remains at the current price.
Near the Next Strike
One of the characteristics of a good covered call candidate is a stock whose price is close to the next higher strike price. The options market sets strike prices at specific prices, such as $5, $7.50, $10 and up. Depending on other factors, such as how volatile the stock is, a stock with a price of $9.80 or $9.90 a share may offer a good premium. A good premium is one that you can make $75 to $125 on in just one or two months.
Lower Share Prices
Good stocks to write covered calls against include those whose stock price is between $5 and $20 a share. You must own at least 100 shares of a stock to write one covered call. Obviously, if the stock is a $50 stock, you must pay $5,000 to buy the stock, as opposed to only $1,000 for a $10 stock. Yet, the option premium prices are not higher just because the underlying stock price is higher. So less money is needed to write covered calls on lower-priced stocks than on higher-priced ones, yet you can generate the same premium cash when selling the option. Rather than tie up large sums of money in one stock, purchase different stocks and write multiple covered calls simultaneously. Or purchase 200 or 300 shares of a stock and write two or three covered calls. This will also increase your profit because commission fees won’t eat up a big percentage of your premium.
High Volatility Stocks
Good stocks to write covered calls against are ones that have high volatility. They will pay higher premiums, giving you a better return on your investment. Stocks with higher volatility (ones that are more prone to wide price swings) are more risky. When you play these stocks, monitor them closely and have a price in mind that if the stock drops below that level, be prepared to buy back the call and sell the stock. It is important to cut any losses before it gets out of control. The website coveredcalls.com gives three free potential covered call stock plays daily and lists the percent return on investment and the period of time for the play (usually one or two months).
Stocks That Pay Dividends
Write covered calls on stocks that pay dividends. Because you must own the stock in order to write a covered call (hence the term “covered,” as you’ve covered the sale), you will be holding the stock until at least the call’s expiration date, and longer if the option isn’t exercised. You may be able to also capture a dividend during this period.