Option Ideas That Beat 229,000 Others

01/27/2012 8:00 am EST


Mike Scanlin from BornToSell.com has scanned the market for the best covered call trades, uncovering a few dozen that satisfy rigid parameters, and now lists them in order of annualized return.

Born To Sell is in the business of screening for covered calls. We are constantly asked how to use a covered call option screener effectively. Investors know that a screener will save them time, but how to do you reduce the universe of 200,000+ covered call candidates down to a handful that you can then do additional diligence on? This article will show you how.

How Many Covered Call Opportunities Exist?

There are 5643 stocks and ETFs that trade (as of this week). Of those, 3716 have call options available. Factor in all the possible expiration dates and strike prices, and there are 229,636 covered call possibilities for today.

Using a Covered Call Option Screener

Not all covered call candidates are worthy of your attention, however. Here is one possible screen that shows how the universe shrinks as you layer on additional filters that remove opportunities that aren’t good trades or investments.

Click to Enlarge

Logic behind each filter:

  • Remove Leveraged ETFs: These ETFs use 2x or 3x leverage and only track their benchmark for a day (start of each day resets their tracking). Because of that, they are not good covered call candidates, unless you are talking about very short-term trades (few days); but even then you need to be really careful
  • Stock price > $5: Don't mess with low-priced stocks
  • P/E Ratio < 20: Removes some high fliers. These are often momentum stocks that pay good call premium, but when they fall from grace, the drop in stock price can be brutal (check out the NFLX chart from July to December last year)
  • Expiration date = Feb 18: The next available monthly expiration date. Writing short-term options results in better time-premium capture (as long as your transaction costs aren't large relative to the premium collected)
  • No earnings before expiration: If you're doing short-term, income-oriented buy-writes, don't take earnings risk. Yes, the premiums are high for stocks about to release earnings, but the stock could drop below your breakeven point overnight
  • Market cap > $500M: Much like the $5 stock price rule, don't mess with small caps in an income-oriented portfolio; they’re too volatile
  • Time premium > 20 cents: This is to avoid having transaction costs eat up too much of your profit. If you are dealing with a large number of shares then transaction costs are probably not an issue and you can relax this rule
  • Annualized return if flat > 12%: If you're not making at least 1% per month, then it may not be worth it. For core holdings where you write out-of-the-money calls to get a little extra income, you can relax this rule (in those cases, even 6% per year would be a nice increase in yield)
  • In the money by 5% or more: This assumes we are looking for new buy-writes where we hope we are called away at the next expiration. This gives us at least 5% downside protection in the underlying stock price
  • Open interest > 2000 contracts: Higher open interest results in tighter bid/ask spreads, which will be important if you want to roll this position later. Wide spreads on thinly traded option series make it expensive to roll
  • No healthcare: There's nothing wrong with healthcare, but in the case of this screen, the healthcare stocks that showed up were all pretty volatile (DNDN, INHX, VVUS, ACHN, MAKO), so we decided to eliminate the group this time

NEXT: The Canidates That Survive the Filter


The Candidates That Survive the Filter

So what are we left with?

Believe it or not, just 38. Less, actually, when you consider some of the stocks and ETFs below are listed more than once because calls at different strike prices made the cut.

The 38 covered call opportunities that remain satisfy all of the above requirements. Now we can begin to look at each one individually and ask ourselves: If we are not called away at expiration, are we comfortable holding the underlying until the next expiration cycle (or even longer)? If not, then don't buy it just for the yield...look elsewhere.

Aggressive traders and investors can look for ideas at the top of this list. More conservative investors will want to look towards the bottom of this list. In some cases, the same symbol appears twice. In those cases, the more conservative approach is to choose the one with the lower strike price.

"Net Debit" is the asking price for the stock minus the bid price for the call (i.e. it is your cost to get into the trade if you buy the stock and sell the call). The difference between the Net Debit and the Call Strike is the amount of time premium (per share) you will make if the stock is called away on expiration day.

As always, do your homework. This is just a screen, not a list of recommendations. Annualized return only means you’d make that much if the stock never moved and call premium could be collected at the same price today every time—neither of which is ever likely.

All of these are for the Feb 18 expiration.

Stock Call Strike Net Debit Annualized
Return If Flat
Cheneire Energy (LNG) 1110.3595.8%
Collective Brands (PSS) 1514.4260.8%
Research in Motion (RIMM) 1514.5051.7%
Sandridge Energy (SD) 87.7548.7%
Cheneire Energy (LNG) 109.7539.5%
MBIA (MBI) 1211.7335.0%
Medco Health Solutions (MHS) 57.556.2235.0%
Sears (SHLD) 4039.1533.5%
Mcmoran Exploration (MMR) 109.7931.9%
Assured Guaranty (AGO) 1514.7130.4%
Morgan Stanley (MS) 1716.7230.4%
Southwestern Energy (SWN) 3130.4228.9%
Research in Motion (RIMM) 1413.7527.4%
Chesapeake Energy (CHK) 2221.6325.9%
Freeport McMoran (FCX) 4443.2725.9%
IAMGOLD Corp (IAG) 1615.7524.3%
Citigroup (C) 2827.6022.8%
Rockwood Holdings (ROC) 4544.3522.8%
Dupont (DD) 4847.6922.8%
SPDR Oil & Gas ETF (XOP) 5453.2721.3%
Silver Wheaton (SLW) 3231.6019.8%
iShares Silver ETF (SLV) 3029.6219.8%
Walgreen (WAG) 3332.7919.8%
Petroleo Brasileiro (PBR) 3029.6219.8%
Transocean (RIG) 4544.4518.3%
Hewlett-Packard (HPQ) 2726.6918.3%
Halliburton (HAL) 3433.6216.7%
Westport Innovations (WPRT) 3534.6216.7%
Freeport McMoran (FCX) 4342.5416.7%
Southwestern Energy (SWN) 3029.6616.7%
Brazil iShares ETF (EWZ) 6362.4015.2%
Gold Minders ETF (GDX) 5251.4815.2%
Occidental Petroleum (OXY) 97.596.6513.7%
US Oil Fund ETF (USO) 3635.7312.2%
JP Morgan (JPM) 3534.7312.2%
Gulfport Energy (GPOR) 3029.7612.2%
iShares MSCI EAFE Index (EFA) 5049.6112.2%
iShares Emerging Mkt ETF (EEM) 4039.6912.2%

By Mike Scanlin of BornToSell.com

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