May Covered Calls

Slim pickin's for covered calls that expire in May. In fact, I only found two candidates that meet my stringent criteria, and they're iffy becomes earnings will be announced before the options expire.

The May options trade for the last time on May 21. That's 25 days away on Monday.


I have some criteria for covered call candidates that run the spectrum from fundamentals to the shape of the chart.

First, I want stocks trading for $20 or under. Covered call positions are so intensive in capital, because I have to own the shares. So I want the price to be fairly low so I don't have tie up too much money. Conversely, anything trading for under $5 is probably that low for a reason. So, I don't want to go below that.

Secondly, I want enough volume for shares and the options to be liquid. I rather arbitrarily set that at a 30-day average of 500,000 shares a day.

Third, I want stocks that look good fundamentally. If a covered call option expires worthless, I'm left holding that stock. If it's going to have a place in my portfolio, even inadvertently, I want it to be shares in a sound company.

I use the InvesTools platform for my fundamental analysis. For anyone familiar with it, I'm looking for a 4 or better on the good side of Phase 1, and 3.00 or better for the F/E scores (which measures analyst opinion).

But any method of analyzing fundamentals will do fine -- rising quarterly earnings, whatever.

Fourth, I want the stock to be sideways or rising on the chart. I use a daily chart covering three months. I estimate the trend just by looking at it. If the price generally tracing an upward or sideways pattern, then the stock is a covered call candidate.

Fifth, I want a decent return whether the option is exercised or not. Decent in my book is 5% or better on either possible outcome.

Here are the candidates I found:

STEC Inc. (STEC) makes Flash solid-state drives for enterprise-level computer systems:

	trend	adx	psar	pps	macd	macd trend	sto	sto trend
STEC $15.88

• trading for $15.88, with volume recently running in the 5 million to 7 million share range
• rates 7 for Phase 1 and 3 for the F/E using the InvesTools method 
• on the chart, the price has been rising since April 15, and in fact the technicals are such that the stock would make a decent short-term directional play to the upside. 
• potential returns are 8.5% if the option expires worthless, and 9.3% if it is exercised.
• earnings, however, will be announced on May 6, so there's the chance of an earnings or news surprise that could cause a sharp drop or rise in the stock price.

Impax Laboratories Inc. (IPXL) is a pharmaceutical company:

	trend	adx	psar	pps	macd	macd trend	sto	sto trend
IPXL $17.32

• trades for $17.32 with volume running in the 500,000 to 600,000 range recently.
• rates 6 on Phase 1 and 3.25 on the F/E using the InvesTools method.
• on the chart has been moving sideways since mid-March, although it is developing a slight downward bias, which is reflected in the technicals
• potential returns are 5.2% if the option expires worthless and 6.2% if it is exercised.
• earnings will be announced on May 4, presenting the chance of a gap up or down if the results run contrary to expectations.

I don't intend to trade either of these, because of earnings being announced within the lifespan of the options.

I rejected a number of possibilities becuse the returns were insufficient. Those rejected are SID, NWL, COCO, OVIP, TWTC, DCP, AMD, SAPE, AMKR, SVM and WTSLA.

One thing that's making it harder to find good covered call trades is that the markets have recovered quite a bit from the recession low. That means prices are high, and fewer quality stocks are trading at $20 or less.

One fix would be to raise the maximum price, which I hate to do because of the high capital needs.

Another would be to play option calendar spreads rather than covered calls.

And a third fix would be to simply do directional plays using options and their vertical spreads, or for sideways trending stocks, using iron condors.

The book to read about covered calls is Show Me the Money: Covered Calls & Naked Puts for a Monthly Cash Income, by Ron Groenke.

The book to read about how to structure option positions as alternatives to covered calls is The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies by Guy Cohen.

I have copies of each of these books on my desk, close at hand, well worn from constant use. I recommend them highly.

Abbreviations:
psar - Parabolic Stop and Reverse
adx - Average Directional Index
pps - Person's Proprietary Signal
ma20 - 20-day moving average
macd - Moving Average Convergence-Divergence
mfi - Money Flow Index
sto - Fast Stochastic

About the glance: The colors indicate the state of each signal.

• trend: Determined by the 5-day moving average, green for up, red for down, yellow for sideways
• adx: orange for above 30-up, blue for 20-down, purple for in the middle. Red is most prone to whipsaws
• psar, pps, macd: green for bull mode, red for bear
• sto: green for overbought, red for oversold, yellow for the neutral zone.

Disclaimer

Tim Bovee, Private Trader tracks the trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.


No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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