There are also metrics like IV Rating, Rank, and Percentile that will give you insight as to how the current implied volatility stacks up relative to historical implied volatility measurements for a stock. Of course, you should remember that a high IV valuation means that the market is priced for increased risk for a reason. If you want to learn more about implied volatility evaluation using these metrics, check out our video on that topic :.
It extends our options-centric stock screener with additional filters for option- and trade-specific properties. The option filters make sure that every proposed trade meets the specified requirements for pricing, open interest, moneyness, and more. You can also use the trade filters to specify whether you want to include or avoid earnings announcements and ex-dividend dates.
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The return filters enable you to specify minimums for risk and reward, both in periodic and annualized forms. The returns are based on the default stock-specific model applied to each underlying for that term. This risk-neutral approach ensures that trades with higher volatility stocks are considered equitably against those with lower volatility stocks. You get a trade summary, an execution plan, an expiration payoff diagram for the default model, and details on the option and underlying stock involved.
Covered call writing is typically used by investors and longer-term traders, and is used sparingly by day traders. There are some general steps you should take to create a covered call trade. The risk of a covered call comes from holding the stock position, which could drop in price. Your maximum loss occurs if the stock goes to zero. Therefore, you would calculate your maximum loss per share as:.
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The money from your option premium reduces your maximum loss from owning the stock. The option premium income comes at a cost though, as it also limits your upside on the stock. You can only profit on the stock up to the strike price of the options contracts you sold. Therefore, calculate your maximum profit as:.
If you sell an ITM call option, the underlying stock's price will need to fall below the call's strike price in order for you to maintain your shares. If this occurs, you will likely be facing a loss on your stock position, but you will still own your shares, and you will have received the premium to help offset the loss.
What is a Covered Call?
The main goal of the covered call is to collect income via option premiums by selling calls against a stock that you already own. Assuming the stock doesn't move above the strike price, you collect the premium and maintain your stock position which can still profit up to the strike price.
Traders should factor in commissions when trading covered calls. If commissions erase a significant portion of the premium received—depending on your criteria—then it isn't worthwhile to sell the option s or create a covered call. I admit that I'm a bit of a broken record about this one, especially when it comes to long term investing , but quality stock selection is also critical when it comes to trading covered calls.
It's so easy to be tempted by juicy premiums on less than ideal companies, but if premium is the only criteria you consider, it won't be long before you really get burned. Covered calls do provide some downside protection, but if the bottom drops out of a stock, you're going to realize just how paltry that protection was. True, when you sell calls for income, stock ownership is temporary and incidental. But even though you're not a long term investor, ownership is still ownership. And in the short term, even temporary ownership of a mediocre company at just the wrong time, can lead to some serious pain.
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The old adage of writing covered calls only on stocks you don't mind owning has a lot of merit to it. If the underlying stock makes a significant move to the downside, you always have the choice of trying some form of rolling out as you wait for the stock to come back. All else being equal, the higher the quality of the company, the more credible that choice becomes. Technical analysis is probably as much art as it is science, but it's still a critical tool in the search for the best stocks for covered calls.
When considering a stock to write calls on, use your favorite stock charting software or check out the free charts at StockCharts and consider various short, intermediate, and longer term time frames. Are you able to see clearly identifiable areas of support and resistance? The easier the chart is to read, the more predictable the stock's price movements are likely to be in the future.
In contrast, a stock is probably not suitable for covered call writing if the share price is erratic, or if it frequently violates major moving averages like the day and the day, or if support and resistance are either unclear or inconsistent.