Covered Call Writing: How To Choose which Option To Sell

Video #6 in our new 7-part series, featuring Roger Michalski and Bryan Perry.

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Covered Call Writing: How To Choose which Option To Sell

ROGER: Hi this is Roger Michalski, Publisher of Eagle Financial Publications. I’m here with Bryan Perry the editor of the Cash Machine and Quick Income Trader. Bryan, we’ve been discussing your covered call strategy over the last several videos, you’ve walked us through an example on the whiteboard, you’ve told us how low-risk it is, you’ve told us how we can get a steady stream of income every month, and you’ve also told us what kind of account we need to set up to use this strategy. But how to you actually pick the individual stock and option to sell?

BRYAN: Well that’s the secret sauce to this particular service here, Roger. There’s always a secret sauce to any good recipe. The business of a really successful covered call strategy is to not mess around with second, third tier names. You want to go with names where there’s good institutional money flow. They’re what we call “institutional darlings” in the stock market. Preferably stocks that have some volatility built into them so they move around a lot. Which gives you expanded cover call premiums, puts and calls, but in our case we’re trying to sell premium back into the market. So we want stocks that do move around a little bit so we can sell an exciting amount of premium back to the market. And in doing so, I use what is called top-down analysis where I look at the industry. Lets say technology, is always a favorite for this particular kind of strategy. And within technology we maybe want to look at cloud computing, one of the hottest sectors in the market right now. And within the sector of cloud computing, then we’ll try to find the right name to work with. Whether it’s Microsoft or or ServiceNow or whatever may be the hottest names within the sector. And then from there, we have fundamental overlay which is the earnings momentum behind the stock and to see whether or not the earnings are accelerating, matching estimates, beating estimates top and bottom line. And whether or not it has what they call overlay technical analysis over the top of that to see if the stock is technically intact, where it has the relative strength (RSI) and momentum that we’re looking for. Money flow is the life blood of most stocks in any given market so we want to make sure all those things line up. Fundamentals, technicals, and we want to also have a stock that prints a lot of good headline so you get a lot of activity and a lot attention. That’s where we want to key in on those types of names. And then also those typical names will be trading very liquid, millions of shares a day, and from there they also have what is attached very liquid option chain next to it. So there’s a lot of open interest, a lot of people working with the options as either speculation, or hedging, or trying to just do what we’re doing here, and that’s bringing in covered call premium as an extra form of income. So what I’ll try to do then is buy the stock as it’s breaking out of a base, so its got brand new upside momentum with no real resistance, and then buy the first pull back. Most stocks they break out, then they pull back, they retest their breakout level and that’s where I want to make my entry point. And then I want to enter a limit order. Once I buy the stock, the second step is to go ahead and sell the covered call. And what we’ll do is sell them just out of the money strike price. So if the stock is trading at $40 we’ll maybe sell the $42.50 call just 5% up from where it’s currently trading. What we’ll try to do is get an extra 4-5%, maybe 6%, from selling that call, the $42.50 call, for the next month or month and a half out, 30-45 days out. The combination of the two, if we get called out at $42.50 a month from now, is you’re going to get 5% for the covered call premium that you brought in plus the 5% appreciation from getting called out. That’s how we can manufacture 10% total return. If the stock doesn’t get called out and you just bring in the call premium, then you’re bringing in 5% every 30-45 days. And if we do the math that gets pretty interesting.

ROGER: Yes, it sure does.

BRYAN: So that makes for a really great combination. Ideally, if you can 5-7 names you can work with where you can continue to go back to the same names month after month and keep riding those horses all year long. You get to know the stocks well, you develop a rhythm for the stocks themselves, and at the same time you understand how the stocks technically and fundamentally are aligned with the best momentum in the market. You want to always be sensitive to where the market rotates into the sentiment, so we also want to be very sensitive to that too. But right now, certainly technology is the place where we’re finding some very good candidates to work with.

ROGER: Alright, and you’re doing that with your newsletter service Quick Income Trader. Tell us a little more about that

BRYAN: Sure. Quick Income Trader is a service built on no more than seven names working for the investor or the trader at any given time. And this way we can concentrate our efforts. And what we’ll do is we’ve designed a model portfolio that’s around $50,000 as a working number that a lot of people are comfortable dedicating towards this king of a strategy. And so therefore, we’re working with stocks that are priced at no more that $70 a share. Typically between $25-$50 is ideal so we can use a 500 share position and sell five covered calls against that stock position. If we can keep that money rotating over the course of the next 30-45 days that’s a wonderful situation because you’re making between 7-10% total returns if that’s the case. Again, if we can also just be in those names all year long and just bring in covered call premium and hold those names as well, then we’re still getting our 5% roughly every 30-45 days on that.

ROGER: Yup, as you said that adds up real quick. Quick Income Trader, a new service of ours, the response has just been overwhelming. I just can’t believe the positive response we’ve gotten. People are getting their money back within the first month often. We’ve just had a lot of happy subscribers, a lot of interest in this, and if you’d like to order Quick Income Trader right now or learn more about the service you can click on the link right below this video.

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