One of the services that we offer to our clients is the use of our stock generation software, Lattco. Lattco allows our clients to screen thousands of stock and call option combinations to determine which will be appropriate for them to buy and trade in their accounts. To non-clients, we recently made available a free covered call screener to view some of the same data for educational purposes. In this article, I will delve into an explanation of just what a covered call is, how we utilize them in our trading of the Snider Investment Method, and how the covered call screener works.
Covered Calls Explained
So just what is a covered call? First, a call option is a contract between two parties. The party who buys a call option is given the right (but not the obligation) to purchase a set of shares at a pre-determined price (called a Strike Price) prior to or on a specific date of expiration. The party who sells the call (as we do when we trade the Snider Method) receives a cash payment (called a premium) for the option. It is called a covered call because it’s a call option that you sell against shares of a stock position that you actually own.
If the buyer chooses to exercise the call prior to or on the expiration date, they will purchase the shares of stock for the strike price from the seller, who is responsible for providing the appropriate number of shares. If the buyer decides not to exercise the call, it will expire worthless on the expiration date.
As mentioned earlier, covered calls are call options that are sold by a seller who owns adequate shares at the time of the transaction to sell to the call option buyer, should they decide to exercise their options. It is possible to also sell what is known as a naked call; this is a call option that is sold by a seller who does not have own the shares to cover the option if it is exercised. Selling naked call options is an incredibly risky investment strategy, and for this reason, we do not practice it in the Snider Investment Method.
Benefits of Covered Calls
There are several benefits to selling covered calls. The primary benefit is the additional income it can generate. In the Snider Method, one of our goals is to produce a “Portfolio Paycheck” of income from selling options in the market, that will take the place of the income we previously made from working prior to retirement. Selling call options represents the majority of the income that we generate off of our accounts (we also make use of selling put options, though not nearly to the same extent).
Another benefit of selling covered calls is downside protection. The premium received for selling the call options can shield the seller from a potential drop in the price of the underlying stock. For example, let’s say that you purchased 100 shares of a stock for $20 (i.e. a total investment of $2,000), and received $100 in premium for selling a covered call against it. This means that, if the price of the stock dipped to $19.50 a share, you could sell the shares in the market, and still net $50 in profit ($50 capital loss offset by the $100 in premium received for the call).
While downside protection is generally beneficial, selling a covered call will also place a cap on the amount of capital appreciation you can receive on your shares. For example, suppose that you buy 100 shares for $20, and sell a call against them with a Strike Price of $25. By the expiration date, the price of the stock has shot to $35 a share. The buyer exercises the call, requiring you to sell your shares to him at $25 per share. You made a profit of $5 per share on this transaction but could have potentially made $15 per share had you not sold the call. This is one of the potential drawbacks to covered calls and the Snider Investment Method.
Our covered call screener implements the first layer of our Lattco stock generator to provide you with data on optionable stock positions. You will start by inputting your search criteria for the screener. This will include your expiration date (the day that the options in question will expire) and a price range that you want to search for stock positions in (for example, stocks that are selling for greater than $25 per share and less than $50 per share). You will also enter whether you want to search for options that are in-the-money (have a strike price that is less than the market price for the stock), are one strike out-of-the-money (have a strike price that is the next highest strike price available above the current market price), or are two strikes out (two strike prices greater than the market price). The screener will also include advanced criteria that is optional for you to enter; this will include entering a bid price (the market price to sell the option for), option volume, and open interest.
After you run the search, the available positions that meet the criteria you input will be displayed for you. The positions are ranked by downside protection, with those offering a greater percentage of protection ranked higher on the list. The 52 Week High and Low prices for the positions will also be included.
While our Covered Call Screener does provide a lot of very good information, the data that it provides is in a raw form. For covered call investors, there are many other factors they need to consider prior to making any trades. Clients who use our online course or attend one of our live workshops are given the ability to use Lattco to generate new positions specifically designed for their investment needs. Lattco utilizes several additional layers of screening to determine proper positions for you to trade; these layers include sector and industry diversification (ensuring that your positions are not overly weighted towards a particular sector of the economy), dividend yield, and market volatility (determining how much the price of the stock has moved up and down).
Lattco is only available to persons who have taken our online course or a live workshop to learn the Snider Investment Method; if you would like to learn more about the Snider Method, or even register for the online course or a workshop, please give us a call at 1-888-6SNIDER or send us an email to firstname.lastname@example.org.