February Covered Call Options Candidates

We're entering prime time for February covered call options. Wednesday is 30 days out from the last day of trading for expiration on Feb. 19. Jan. 30 will be 20 days out. So that defines my window for trading this strategy.

Before I show my list of prospects, here is how I did the scan. . . .

I looked 200 stocks valued between $5 and $20 a share, sorted by volume in descending order. That got me down to about 3 million shares in volume. I then did an immediate weeding by looking at the Person's Proprietary Signal (pps), a very visible commercial "black box" indicator that gives very clear (and fairly reliable) bull/bear signals. The pps is available on the brokerage Think Or Swim's trading platform. (The best platform around.) Any other easily read and unambiguous signal will do, of course. The Commodity Channel Index (CCI) is a good open-source alternative.

If the pps was in bear mode, I rejected the stock out of hand.

If the pps was in bull mode, I next looked at the premium on the nearest out-of-the-money option. For example, if a stock is selling for $15.75 per share, then the nearest OTM call has a strike price of 16 (assuming the strike prices are a dollar apart, as they are on most stocks costing 20 or less).

I divided the premium by the strike price to get a percentage. That tells me how much stop-loss cushion I'm getting in case the stock price falls. I wanted at least 5 percent. Anything less that, into the trash.

Next, I looked for the next earnings release date or conference call. If something was scheduled during the life the option, then I lost interest. I'm a traditionalist in that I adhere to the old saying, which no doubt dates back to some very smart private trader on the Paris Bourse of 1815: Buy on the cannons, sell on the trumpets, especially if they come from the direction of Waterloo. The earnings release is the trumpets. I don't like the risk of holding a covered call over earnings.

Of course, my window for selling covered calls is anytime from 20 to 30 days before expiration. So, if earnings happen sometime before Jan. 31, I will note the stock but won't trade until after earnings (and only after repeating my analysis).

After that, it's a question of doing the normal due diligence. Is the stock trending sidewise or up. Slightly up is better than explosively up, but either way it's not a deal killer.

What do the other indicators tell me? I look at the the bull-bear status of the Money Flow Index, the Stochastics, the MACD, the Bollinger bands, but everyone has their own favorites.

And I check the news about the stock. Is there something going on that will cause sudden news-based moves.

With all of that in hand, I choose.

Here's the list:

Stock	Strike	Premium	Percent	Earns
PALM	14	0.91	6.5
UAUA	14	0.95	6.8	Jan. 27
DAL	13	0.85	6.5	Jan. 27
SWKS	15	0.75	5.0	Jan. 20
ZION	17	0.85	5.0	Jan. 25
AXL	10	0.75	7.5	Jan. 25

So, in my list only one is tradeable immediately: PALM. The rest have earnings in late January.

I'll limit today's analysis to PALM and jump in with the others as they announce earnings. PALM released its earnings on Dec. 17.

PALM has been on the rise since mid-December and is at 13.56 is bumping up against its 200-day moving average. Support is at about 12.55, and resistance at 15.95. Lot's of upside. All of my secondary indicators are in bull mode. The price has pushed against the upper Bollinger band and widened the spread in an extreme bull move.

My analysis in the table has the strike above the trading price, or Out of The Money, which is appropriate for a rising stock. If the current trend continues, the call will be exercised, and I'll sell my stock for 14 no matter how high its trading. My profit on OTM covered call will be 1.35 (91 cents premium plus 44 cents profit on the shares).

But PALM is a volatile stock. The average daily trading range over the last 14 trading days is 76 cents wide. So, from present 13.56, that could put Tuesday's price as low as 12.81, if its an all-down day.

The high Bollinger band profile suggests the possibility of a pullback. The OTM strategy makes my breakeven 12.65, which is above support.

An alternative would be to go one strike In The Money, at 13, with a premium of 1.38. That would give me a 10.2 percent cushion and a breakeven of 12.18, below support.

If the stock fell, the call wouldn't be exercised, and on Jan. 20 I would still own the shares and would have pocketed the premium.

The fact is, either strike can be counted as At The Money, which is appropriate for a neutral, sideways stance.

If I move up one strike OTM, to 15, then my premium is 55 cents, or 3.8 percent, my breakeven is 13.01 and my maximum profit is 1.95. Since 15 is below resistance, it's an acceptable risk from the standpoint of price analysis.

If I move down one strike ITM, to 12, then my premium is 2.01, or 16.8%, my breakeven is 11.55, and my max profit is 45 cents.

(I'm ignoring brokerage fees.)

Here it is in table form:

Location	Strike	Breakeven	Max Profit
OTM (+1)	14	12.35	1.65
ITM (-1)	13	12.18	1.38
OTM (+2)	15	13.01	1.95
ITM (-2)	12	11.55	0.45

You pays your money and you takes your choice. (Actually, that phrase appeared in the British humor magazine Punch in the mid-19th century. It has been around awhile.)

New to Private Trader? Check out the Reader's Guide. Read my review of Ron Groenke's covered call bookShow Me the Money

Some blog mentions of PALM:

• Barron's Tech Trader Daily: Crazy rumors
• Find Best Smartphones: Palm Pre sold out on launch day
• Fanboy.com predicts Palm will switch to Android and then fade away

Topics:
Palm mobile phones cellphone communications telcom, UAL Corp. United Airlines aviation, Delta Air Lines, Skyworks Solutions, Zions Bancorporation finance, American Axle and Manufacturing Holdings automotive.