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A Covered Call Alternative
Covered Calls are what I consider a BORING trade. However, they are also considered one of the most conservative as well as safest trades. In reality, if you know how to search for covered call opportunities (understanding volatility and how it applies to options) you can make some handsome returns. It is relatively easy to earn 5% or more per month. That's an annualized return of 60%. I bet you are not getting that on your CD!
Most Covered Call traders sell options that will expire within the next 4-6 weeks. In doing so they are capitalizing on the positive Theta that occurs as they approach expiration. Theta is the value of time decay that the option experiences. Simply put, if it is June (as it is when I write this Hub) and you sell a July option the value of that option will deteriorate much faster than an October option. While the October option has a higher premium, you have to wait much longer to collect the premium.
By virtue of the fact that you are reading this Hub I think it is safe to assume that you are not planning on day trading and you don't have a problem waiting awhile to receive your gains in a conservative manner. This is what the covered call is all about. Let me show you how to increase your returns with this safe approach to stock investing.
First of all we want a stock that presently has higher Implied Volatility (IV). Don't get scared by this, it is actually fairly easy to locate. First of all you can easily check what the IV on a stock is by going to www.ivolatility.com. You have to have an account, but accounts are free so create an account and check the volatility of the stock before you invest. The higher the volatility the higher the premium of the option you are selling. Therefore, you will collect more premium and as volatility drops you will collect the premium of the option you sold quicker.
Second, you want to locate stocks that pay dividends. You can do a dividend scan at www.finviz.com. Once you gather a list of stocks that are paying dividends you can then check the volatility on this to skim down your list to the ones that have a higher IV. By doing a covered call on a stock that pays a dividend allows you to collect the dividend if you hold the stock through the payout.
Third you want to sell an option that is on the other side of the dividend payout date. You are looking to sell the option 1 - 3 months out. Understand that options are not available every month. Therefore three months out is not referring to September if you are in June. It is the third month that options are available. You are going to hold this trade longer so that you collect the extra premium that comes with the extra time while also allowing you to be in the stock longer for the dividend payout.
As you are identifying the option to sell focus on the Delta. You want to sell an option that has a Delta of .50 - .75. Not only does the Delta deal with the amount of change in value based on the underlying stock price, but it also tells you the percentage chance of the option expiring in the money (ITM). If the option is ITM at expiration the stock will be taken from you and you will keep all the premium collected when you sold the option plus any dividends paid while you owned the stock.
If you sell an option with a .60 Delta there is basically a 60% chance that this option will expire in the money. The high Delta will give you a higher premium yet still out of the money (OTM) giving you the opportunity to also profit from the increase in the stock price.
Utilizing this strategy you will receive income from three different sources assuming that the price of the stock continues moving up:
1. Profit from collecting the premium of the option sold
2. You will collect a dividend while you own the stock
3. You will profit from the difference between the current price of the stock and the strike price of the option.
Following this strategy could produce some handsome yet safe returns.