# Covered Call Writing: Strike Price Selection And The Ellman Calculator

Covered call writing requires a logical sequence of stock and option decisions. Once we have screened our stocks to locate the greatest performing stocks in the greatest performing industries we must make a decision as to which strike price to use. Our choices include:

• in-the-money
• at (near)-the-money
• out-of-the-money

Let's look at the options chain for the December contracts which represent a 4-week period expiring on December 16th. This was the options chain after the November contracts expired:

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Red Hat (NYSE:RHT)- Options chain for the December contracts

With the current market value @ \$49.04, I have selected the following strikes to evaluate (additional strikes can also be viewed):

• \$47 in-the-money (green field) generates \$3.60
• \$49 near-the-money (yellow field) generates \$2.40
• \$52.50 out-of-the-money (purple field) generates \$0.95

Next let's enter these stats into the "single tab" of the Ellman Calculator:

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Ellman Calculator- information entered

Once this information is entered in the blue cells, the results appear in the white cells on the right side of the page:

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RHT- Ellman Calculator results

Each strike tells an important story:

\$47 (green field):

• 3.3%, 1-month initial return
• 4.2% downside protection of the option profit
• No upside potential

\$49 (yellow field):

• 4.8%, 1-month initial return
• Little or no downside protection or upside potential

\$52.50 (purple field):

• 1.9%, 1-month initial return
• No downside protection of the option profit
• 7.1% upside potential (possible total of 9%, 1-month return)

What these calculations tell us:

• The time value or option profit for I-T-M strikes offer lower returns than the near-the-money call but the greatest protection for the option premium
• A-T-M (near) calls provide the highest ROO (initial premium profit) but little or no upside potential or downside protection of the premium
• O-T-M calls offer less option profit than the A-T-M calls but the greatest total profit potential should the upside be realized or almost realized.

When to use each strike:

• I-T-M strikes are the most conservative and easiest to unwind because of their high delta (move down in price nearly dollar-for-dollar with stock price decline). Use these when technicals are mixed and/or the market is bearish or volatile.
• A-T-M strikes can be used when technicals are good and market conditions are positive.
• O-T-M strikes are used when extremely bullish on the stock and general market conditions are favorable