There are certain characteristics to look for when targeting stocks for a covered call trading strategy. The overall goal while seeking a company that is worthy of this strategy is to adhere to certain filtering characteristics . For example, it would be unwise to buy company ABC to sell covered calls on because their stock price is low. ABC may very well have a falling stock price because their debt is out of control. This is why I have developed these characteristics to stick to when pursuing companies:
·High (Greater Than 1 Million) Average Daily Trading Volume
·Dividend payers is always a bonus, but not required
Why don’t we dive into these characteristics a little bit here, starting with Low Stock Price. The reason behind this is fairly obvious if one understands selling covered calls. To sell a covered call on a stock it is a requirement to possess 100 shares. It is much more affordable to buy 100 shares of a company selling for 3.00$ ($300.00) than to go out and buy 100 shares of a company whose shares are trading at $500.00 ($50,000). The annual yield from selling covered calls on a lower priced stock will always be higher (even though it shouldn’t be). Not to mention many small time retail investors don’t lug around 50K in their trading accounts.
Let’s move on to the second bullet point; Healthy Financials. This must be analyzed for obvious reasons. We do not want a company that has decreasing revenues or growing debt. These are signs of a struggling company that will lead to a stock price decline. The goal here is to find a “Steady Eddie” sort of stock that will cruise along at its current price. Or in other words steady revenues and steady/steadily lowering debt levels.
After these checks we want to look at a company’s Average Daily Trading Volume. This is on the list of characteristics because the average daily volume of a stock is directly correlated with a stock’s options market spread on the bid to ask price. Or, put into simpler terms, the more times a stock trades in a day the more options trade on the respective stock as well.
Here are my top picks for covered calls for the week of 8/15/11 – 8/19/11 with the annualized yield (assuming the call will be sold 12 times at the same price as the first sale).
* To note: I am selling the first out of the money call