Covered-call writing strike selection will vary from investor to investor, says Alan Ellman of The Blue Collar Investor.
There is no single parameter that will guide us to the most appropriate strikes for our portfolios. Factors that must be considered are personal-risk tolerance, initial time-value return goal range, and overall market assessment.
The type of underlying securities we use and the “moneyness” of the strikes play a major role after determining the degree of risk we are willing to accept. Those with extremely low risk tolerance will favor low implied volatility stocks and ETFs and in-the-money (ITM) strikes.
More aggressive investors will incorporate higher IV securities and add in out-of-the-money (OTM) strikes.
Initial Time-Value Return Goal Range
The higher the potential returns, the greater the risk. We must establish this range prior to entering any of our option-selling trades. My preference is to have an initial time-value return between 2% and 4% for monthly contracts. This is the range I will use for this article:
Overall Market Assessment
- Bear markets: Favor ITM strikes which offer greater protection to the downside.
- Neutral markets: Favor near-the-money strikes which generate the highest initial time-value returns with little or no downside protection of that time value profit or upside potential.
- Bull markets: Favor OTM strikes which offer two potential income streams, one from option premium and the other from share appreciation up to the strike price.
CROX (CROX) Option Chain with CROX Trading at $153.66 on 10-22-2021 (29-Day Return)
CROX: Call Option Chain on 10-22-2021
- Yellow: $145.00 strike (ITM)
- Brown: $155.00 strike (near-the-money or slightly OTM)
- Green: $160.00 strike (OTM)
CROX calculations with the BCI Elite Calculator
CROX Covered-Call Writing Calculations
- Yellow: Initial return on option (meets our 2%-4% criteria)
- Brown: Upside potential (share appreciation potential in bull markets)
- Green: Downside protection of the initial time-value profit (intrinsic-value protects time-value in bear markets for additional protection to the downside)
Strike selection is as much an art as it is a science. We must first establish our initial time-value return goal range. From there, we factor in personal risk-tolerance and overall market assessment. With these factors considered, strike selection will result in a well-thought-out plan.
Learn more about Alan Ellman on the Blue Collar Investor Website.