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With 10 trading days until the Feb 18 option expiration, here are 10 income-oriented covered call trades you can make to take advantage of the rapid time decay of call options during their final 10 days.

The Game Plan

Our goal is to execute buy-write trades (where you by stock and write a call option against it for income) with in the money call options. Hopefully they will be called and we'll be back to cash on Feb 18. But in case they are not called, we will want to choose companies that we don't mind holding for the March option cycle. If we're not called, then our plan will be to write March options at the same strike as the February ones that weren't called (or, if something has changed and we no longer like the stock we may just sell it at a loss and move on).

Covered Call Screening

According to Born To Sell's covered call screener, there are 47,880 covered call candidates with a Feb 18 expiration date. Let's layer on a few filters to narrow the field:

covered call filter

Reasons For Each Filter

No leveraged ETFs: These aren't meant to be held for weeks at a time. Better used for day trading (if you're into that kind of thing).

Stock price > $5: In general, it's a good idea to stay away from stocks under $5/share.

P/E Ratio < 20: Remove some high fliers from the list. When they become out of favor they can drop dramatically (as anyone who owned Netflix (NASDAQ:NFLX) last year will know).

No earnings before expiration: Yes, earnings make for juicy premiums, but for an income-oriented portfolio they are just too volatile for short-term buy-writes.

Market cap > $500M: Similar to the $5 stock price rule, let's stay away from small caps. These are sometimes very volatile.

Time premium >= 35 cents: If you're dealing with a large number of shares then you can relax this filter a bit. For smaller trades we need to makes sure the commissions don't eat all of the profits.

Annual Return If Flat > 12%: This is the annualized rate of return if the stock price remains flat (unchanged) by Feb 18. Actually, since our filter looks for in the money options only (next filter) this could also be called Annual Return If Called, because as long as the stock price is above the strike price you will get this amount of return. If you're not making at least 1% per month (12%/ year) then it's probably not worth doing (for short-term buy-writes anyway; if you're writing out of the money calls on core long-term stock positions then you can relax this filter).

In the money 5% or more: The goal of these short term buy-writes is to generate income, not speculate for capital appreciation. So we'll want a decent amount of downside protection. 5% for 10 days seems reasonable.

Open interest > 2000: Option series with higher open interest make for smaller bid-ask spreads. That's important in case you need to roll the option to a different strike or expiration. Since this is only a 10 day trade it's probably not a big factor here (you are unlikely to roll in 10 days), but it's good practice to stay away from thinly traded series.

No healthcare: There's nothing wrong with healthcare per se but this screen resulted in some volatile healthcare names showing up so we're going to remove them from this set.

The Finalists

Symbol Stock

Price

Call

Strike

Net

Debit

Time

Premium

Annual

Return

NOV 82.04 77.50 77.04 0.46 14.6%
HES 60.36 57.50 57.06 0.44 19.5%
FCX 46.55 44.00 43.62 0.38 21.9%
CNX 37.76 36.00 35.63 0.37 24.3%
WDC 38.53 36.00 35.65 0.35 24.3%
WLT 76.49 70.00 69.34 0.66 26.8%
SHLD 44.59 40.00 39.54 0.46 29.2%
RIMM 16.90 16.00 15.61 0.39 60.8%
SPRD 18.29 17.00 16.54 0.46 68.1%
MMR 12.79 12.00 11.64 0.36 75.4%

How to read the table

Let's look at the first row. If you were to buy 100 shares of NOV for $82.04 and then sell 1 Feb 18 call option with a strike of 77.50, your net debit would be 77.04 (net debit = stock price minus what you receive for the call option you sold). The call price is not shown but you can calculate it by taking the Stock Price and subtracting the Net Debit. In this case the call price would be 82.04 - 77.04 = 5.00; you would sell 1 call option for $5 (and since it controls 100 shares you receive $500).

If NOV stays above the strike (77.50) by Feb 18, then you will be called and receive 77.50 per share for your stock. Your profit is the time premium because you sold the stock for 77.50 and you bought it for the net debit of 77.04. So you made 46 cents per share profit. That's 46 cents on an investment of 77.04. If you annualize that return it's 14.6% per year.

Homework

Now your homework begins, because the above list is not a list of trade recommendations. It is merely the result of a set of filters as a reasonable place to start looking for trades. You will need to study each stock and see if you are comfortable holding it beyond Feb 18. If you're not, then don't do the trade just for the short-term income, because if it drops below the strike price by the 18th you'll still own it.

Diversify

As with all trading strategies, don't put all your eggs in one basket. If you're going to do buy-writes for income then you still need to adhere to reasonable position sizing and diversification.

Commissions

You will want to consider your transaction costs when doing these short-term income trades. If your commission to buy 100 shares is $5, your commission to sell 1 call option is $5, and your commission when assigned is $5, then that's $15 round-trip, or 15 cents per share. When the time premium is 40 cents a share, that 15 cents will make a big difference in the actual realized returns.

Assuming your commissions are relatively flat for 1000 shares or less, you can lower your transaction costs per share by doing more shares. For example, 300 shares with the same commissions would lower your transaction costs from 15 cents per share to 5 cents per share. And 1000 shares would make it 1.5 cents per share. At that point you can almost ignore commission costs (which is also true if you trade at a super low cost broker like Interactive Brokers).

If you don't have the capital to by 500 shares of several stocks or ETFs then you should look for buy-writes that have more time premium per share. Perhaps the same filters as above, but applied to the March 17 expiration instead of the Feb 18 expiration. That extra month of time will definitely buy you more time premium and reduce your transaction costs as a % of your profits (of course, you are exposed to the underlying stock for an additional month, too).

Source: 10 Option Trades For The Next 10 Days