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3 Covered Call Ideas For May 17th

Barchart - Tue May 17, 1:29AM CDT
Food, Bev & Cannabis - engin-akyurt-NlGjqcPACUw-unsplash(1)

Covered calls are a great strategy to add to any portfolio, particularly in this era of low yields. Covered calls can offer enhanced yield from stock holdings, in some case, that can be a significant increase.

To trade a covered call we need to own (or buy) 100 shares of a stock and then sell a call option against that stock position.

The goal is to generate income from the stock holding in addition to any dividends. The premium received from selling the call also covers a small decline in the stock price. However, the trade off is that stock gains are limited above the call option strike price.

High volatility stocks have the highest return potential with covered calls, but they also have the highest risk of an adverse price movement. It’s all about finding a strategy that fits the investors risk tolerance.

Let’s look at a few examples using Barchart’s Covered Call Screener.

This first example shows the results of the screener with the default parameters selected.

This result returns some stocks with very low market capitalization and, while the returns look great, the risks can also be very high.

Let’s add a filter for Market Cap over 60 billion and 60-month Beta below 1.00.

Now, we’re seeing some more mainstream names such as BABA, ABNB, MMM, NKE, and V.

NKE Covered Call Example

Let’s evaluate the first NKE covered call. Buying 100 shares of NKE would cost $11,260. The July 120 strike call option was trading yesterday around $4.25, generating $425 in premium per contract for covered call sellers.

Selling the call option generates an income of 3.92% in 59 days, equaling around 24.27% annualized. That assumes the stock stays exactly where it is. What if the stock rises above the strike price of 120?

If NKE closes above 120 on the expiration date, the shares will be called away at 120, leaving the trader with a total profit of $1,165 (gain on the shares plus the $425 option premium received).

That equates to an 11.0% return, which is 67.1% on an annualized basis.

NKE is currently followed by 19 analysts with 16 Strong Buy ratings, 1 Moderate Buy rating and 2 Hold ratings. The Barchart Technical Opinion rating is an 100% Sell with a strengthening short term outlook on maintaining the current direction.

The current IV Percentile is 86% which means that the current level of implied volatility is higher than 86% of all occurrences in the last 12 months.

Selling Calls Closer To The Stock Price

The previous example shows a very nice potential return, but required the stock to rally significantly to achieve the full return. Let’s adjust the screener slightly so that we can find more income focused covered calls. We can do this by changing the Moneyness filter to be -5% to 0%. This will give us covered calls that are closer to at-the-money. This means they will have less capital gain potential and focus mainly on the income portion of the trade.

Here are the results:

Here we see the annualized returns are lower because the covered calls are closer to the money which means less capital gain potential. However, as you will see the return from the sold call will be higher if the stock stays flat.

Let’s use NKE again as our example:

The July 115 strike call option was trading yesterday around $6.20, generating $620 in premium per contract for covered call sellers.

Selling the call option generates an income of 5.83% in 59 days, equaling around 36.05% annualized. 

If the stock rises above 115 at expiry, the total return would be 8.4% or 50.9% annualized.

Here is another example using Starbucks (SBUX). Buying 100 shares of SBUX would cost around $7,242. Selling the 75 strike call with a July expiration date would generate around $292 in covered call premium. 

The total capital at risk would be the $7,242 to buy the 100 shares less the premium received of $292. That equals $6,950 capital at risk.

If we take 292 divided by 6,950 that gives us a potential return of 4.20%. On an annualized basis that is 25.99%.

If SBUX closes above 75 on July 15, the shares would be called away and the total return would be equal to the gain on the stock ($258) plus the option premium received ($292) for a total gain of $550 or 7.91%.

That is around 48.1% annualized.

The Barchart Technical Opinion rating is a 100% Sell with a strengthening short term signal outlook on maintaining the current direction. Long term indicators fully support a continuation of the trend. Traders may prefer to add a parameter to the screener to find only stock with buy ratings.

The current IV Percentile is 92% which means that the current level of implied volatility is higher than 92% of all occurrences in the last 12 months.

Please remember that options are risky, and investors can lose 100% of their investment.  This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

*Disclaimer: On the date of publication, Steven Baster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, May 16, 2022.