Covered calls are a popular way to generate income in a retirement portfolio. While holding a long stock position, you can sell (write) a call option and collect the premium as income. The only downside is that you may have to deliver the stock if the price rises beyond the call’s Strike Price. It’s a win-win proposition as long as you’re comfortable selling the stock if it appreciates.
Let’s look at how to choose the right stocks and options, manage covered calls over time, and boost your portfolio’s income.
Choosing the Right Stock
Many long-term investors use covered calls to generate an income using their existing portfolios. If that’s the case, you can write covered calls against any position where you own at least 100 shares. However, it’s important to consider key events that could impact the price like an earnings announcement or approaching dividend payment. You must also be comfortable selling the stock and triggering capital gains if the price ends above the call’s strike price.
Traders and investors using buy-write strategies typically select stocks based on their suitability for covered calls. Since you’re on the hook for any decrease in the stock’s value, it’s best to choose stocks that you’re comfortable owning over the long term. It’s a good idea to look at its fundamental value and recent technical trends, too.
Other factors to consider include:
- Downside Protection
- If-Called Return
- Annualized Return
- Upcoming Earnings
- Ex-Dividend Date
OptionDash makes it easy to find covered call opportunities – Source: OptionDash
Covered call screeners are the easiest way to identify suitable stocks. For example, optionDash provides a comprehensive screener that lets you sort opportunities by downside protection, if-called return, or annualized return. The platform also provides a proprietary Quality, Value, and Trend scores to help ensure that the underlying stock is safe to own.
Choosing the Right Option
The next step is choosing an option with the right strike price and expiration date. Not surprisingly, conservative strike prices and expiration dates provide less income than aggressive ones. The right choice depends on how much income you want and how much “upside” risk you’re willing to accept (e.g., opportunity cost if the stock rises).
Long-term investors often prefer out-of-the-money options. That way, they minimize the risk of the stock being called away and leave the door open to additional capital appreciation. On the other hand, those using buy-write strategies may prefer in-the-money or at-the-money covered calls to maximize income and downside protection.
Other tips to remember include:
- Initiate covered calls when implied volatility (IV) is high since the market tends to overshoot its predictions.
- Avoid selling very cheap options since they don’t provide meaningful income and limit upside potential.
OptionDash and other covered call screeners can also help select the best strike prices and expiration dates. For example, you can compare annualized returns, if-called returns, and downside protection to determine the right risk/reward combination for your situation by exploring different combinations of expiration dates and moneyness.
Managing the Trade
Most long-term investors have a set-and-forget mentality, but covered calls require regular attention. If the stock suddenly rises, investors may need to buy back the option to avoid the stock being called away—an event that could trigger capital gains taxes. If the stock falls, investors must decide if they still want to keep the stock.
The two most common ways to deal with positions that go awry are rolling up, rolling out, or closing the position. Rolling up refers to closing out the existing call option and selling another with a higher strike price. Rolling out refers to closing out the current call option and selling another with an expiration date further into the future.
Most of the “action” in options happen in the final week leading up to expiration. Early assignments are very rare, and typically only happen if the strike price is deep in the money or an upcoming ex-dividend date. Most new traders are surprised to learn that option won’t be exercised immediately after the stock’s price exceeds the strike. If you’re concerned about the underlying stock falling, you can also purchase put options as a way to hedge against declines without closing out the covered call.
The Snider Investment Method provides a more comprehensive strategy to address every possible outcome. For example, the strategy addresses what to do if the stock appreciates or drops in price, how much to allocate to each particular stock, and how many options contracts you should sell against a stock to maximize income and minimize risk.
The Bottom Line
Covered calls are a popular way to generate income in a retirement portfolio. While it’s a straightforward strategy, you have to select the right stocks and options and manage the trade over time. Fortunately, there are many tools and strategies available for new traders. optionDash can help screen for opportunities, and the Snider Investment Method teaches you how to manage these trades over time. Take our free e-courses today!
In addition, investors using covered calls as their primary means of generating income may want to check out our Lattco automated trading software. The platform automatically suggests covered call trades and automatically pulls up option chains and checks strikes and bids to bundle transactions—making the entire process a lot easier.
Snider Advisors also provides asset management services to those interested in having experts handle their portfolios. For example, business owners that are busy running their business, elderly people that need extra help, or families that aren’t interested in managing their own assets. Contact us to discuss these opportunities in greater detail.
