When selling time value, you will use a different philosophy than those stock investors looking for a stock to go up in price. Your gains will come from the time value of the options you will sell. This approach to stock selection is unusual. Most investors use fundamental analysis or technical analysis while you will use the time value of s stock’s options, tempered by fundamentals and long-term hold principles.
Deciding to create a covered call trade requires choosing an expiration month and strike price. Option strategies require making modifications during the life of an option trade. The option expiration month you select will have significant impact on the success of any option trade.
There are at least four different expiration months available for every stock on which options trade. Initially, the CBOE set up only four months for options but later LEAPS were introduced so it was possible for options to be traded for more than four months on stocks with LEAPS options. When stock options first began trading, each stock was assigned to one of three cycles: January, February or March. Stocks assigned to January cycles will offer options in the months of January, April, July and October. The same quarterly sequence will hold for the February and March option cycles. Under the new rules, the first two months are always available but for the later months the original option cycles are used.
To select a stock for your covered call portfolio, you must have available a current option chain list. You can select the expiration month based on the time value of the stock options and the strike price. Then, if the stock meets your stock selection criteria, but it as the underlying stock in your portfolio.
To get an annual return of 20% or more, you must find available options with time value that will produce a 2% return each month or 5% each three months on the price of the stock. Using the option chain list, you can calculate the percentage of stock price that the time value represents. Of all the optionable stocks, you can find at least 5 to 10 stocks to consider. If the time value seems attractive, then look at the fundamental and technical analysis to make your decisions.
Personally, I like to sell an option in the current or next month with a time value return of no less than 3%. However, I will caution all covered writers to proceed with caution if the time value return is very high as usually there is something pending with the underlying stock such as a news event, earning release and other items. Volatility can play a significant role in the pricing of options so the higher priced time value options usually have a significantly higher volatility.
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