How to Find the Right Stocks for Covered Calls

  by Shelley Seagler

Covered calls are a great way to generate extra income in your portfolio. However, while the strategy is pretty straightforward, questions quickly arise when beginners start to implement it. The first question is usually, “how do you choose the right stocks for covered calls?” Of course, the answer ultimately depends on your goals and market sentiment.

Let’s take a look at how to find the right stocks for covered calls, as well as some of the best tools to help make the process easier.

For Long Investors

Many long-term investors use covered calls to generate income from their existing portfolio holdings. For example, you might own AAPL in a long-term portfolio and write covered calls to increase its yield. The goal isn’t to generate as much income as possible but instead generate a little extra income beyond the stock’s dividend yield.

If you fall into this category, the right stocks for covered calls are simply those you’d like to own. When you sell a call option, you forfeit any upside beyond the strike price, but you keep the premium income. Also, the premium income will offset some of your losses if the stock falls, although long-term holders aren’t typically concerned with short-term losses.

Even if you plan on always owning the stock, you should still be wary of upcoming dividends and earnings dates when writing a call option. In particular, earnings tend to lead to higher levels of volatility. So if the call option happens to move into the money, you may have to either buy back the option or give up the stock (potentially triggering taxes).

For Income Investors

Some traders use buy-write strategies purely for income. In other words, they select the long stock based on the income potential from writing the call option. These strategies involve a lot more due diligence when selecting stocks and options. Fortunately, there are a few different techniques that you can use to tilt the odds in your favor.

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A common strategy is comparing implied volatility (IV)—a proxy for market sentiment—with historical realized volatility (HV). When IV generally outpaces HV over a given term, covered calls should be profitable over that term. Of course, you must adjust for earnings, dividends, or other factors that could skew the numbers.

Many traders also look at the downside protection and if-called return. The if-called return is the return that you’d realize if the call option holder calls the stock. Meanwhile, downside protection is the extent to which the option premium offsets losses in the underlying stock. Both of these metrics can help you assess risk-reward trade-offs.

Screening for Opportunities

Option screeners make it easy to find the right stocks for covered calls. Rather than going through individual stocks, screeners create a list of stocks that meet specific criteria and enable you to sort the list to find the best opportunities. There are many different option screeners available, including some that offer a free tier or free trial.

Covered Call Stocks

optionDash makes it easy to spot covered call opportunities. Source: optionDash

optionDash is one of the best option screeners that’s purpose-built for covered calls and buy-write strategies. You can quickly screen for opportunities based on criteria ranging from market capitalization to proprietary quality scores. Then, you can sort the stocks by if-called returns, downside protection, or other metrics.

In addition to its slick UI, the screener’s main claim to fame is its proprietary scoring system that incorporates a stock’s value, quality, and trend. You can quickly assess if the underlying stock is over or undervalued, its risk of bankruptcy, and whether it’s trending higher or lower—all critical factors in tilting the odds in your favor.

Taking the Next Steps

Finding the right stock to buy for a covered call strategy is a critical first step, but there’s more to covered calls than picking a stock and selling a call option. For example, how much money should you allocate toward a particular stock? What strike prices should you use? And, what do you do if the stock falls in price and you don’t want to own it?

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The answers to these questions could take up an article of their own—and we cover many of them on our blog. But, if you want the easiest way to get started, we provide a free e-course teaching the Snider Investment Method—a strategy we’ve built over the years to answer these questions and offer a comprehensive approach from start to finish.

We’ve also built Lattco to make it easier than ever to execute your covered call trades and track your success over time. Built specifically for the Snider Investment Method, the platform makes it easy to execute trades automatically, generate portfolio reports, and ensure that you have the right level of diversification.

The Bottom Line

Covered calls are a popular way to generate income beyond dividends. While the strategy is pretty straightforward, many beginners have trouble identifying the right stocks to buy. Fortunately, covered call screeners, like optionDash, make it easy to narrow down and sort through different stocks to find the best opportunities. Get started for free!

If you’d rather avoid the time and effort of finding opportunities, we provide a done-for-you solution via our asset management services. Contact us for a free consultation to learn more.

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