What Are The Best Stocks For Covered Call Writing?

Once upon a time, finding the good ones was difficult, to say the least. Only a few institutions or asset management firms, perhaps, had access to a data feed of option prices and the software to exploit it. There was little demand, since funds and other money managers with substantial exposure to equities tended to sell calls on holdings.

Buy-writing was much less common back in the day, simply because the information was not available. And for the individual investor, there was nothing – except the newspaper (if the newspaper offered yesterday’s closing option prices) and a calculator.

Covered writers would plow through the paper and do a basic return calculation, the problem being that option prices for a stock were never next to the price of the stock, so we had to go back and forth between two different parts of the financial section.

My, how times have changed. There are quite few websites that offer either lists of covered call candidates or some sort of screener that allows a search for candidates according to fundamental criteria the user can choose. Lists or scan? Each approach has its advantages and disadvantages.

Covered Call Scans

There are websites that allow you to scan the market for the highest-returning covered call trades and to include fundamental data points in the scan’s query parameters, as well – such as PE ratio, market capitalization and earnings per share. Such scans are customizable, at least to the extent of the preset query parameters included.

Scanning systems allow, at least within the limits of their included presets, a certain amount of flexibility. But scanning systems raise an interesting question: do you know what to scan for? In other words, if you introduce a particular parameter into a scan, will it in fact produce better trade candidates? The goal is to produce a list of high-quality trade candidates, but can you design a scan which accomplishes this goal? This would seem an easy answer: include only those parameters intended to find high returns on great companies. But of course, no scan will produce uniformly good candidate trades (nor will a list), because software cannot truly produce a black box for covered call writing.

I once spoke with a lady who had used such a scan, using such restrictive quality parameters that it produced only a handful of companies, of which she wrote Caterpillar (CAT) for a nice premium. CAT then promptly tanked when it missed earnings estimates a few days later. She ruefully admitted that, just maybe, there was more to picking “great” covered call stocks, even when using the most restrictive imaginable query parameters. And so there is.

Covered Call Lists

The vast majority of “covered call” websites provide lists of covered call trade candidates. These lists may be very simple and lump all trade candidates, irrespective of quality or stock price, together on one or a few lists, and most only provide lists based upon end-of-day data.

Personally, I prefer the lists approach. Scans based on fundamental data points are too limiting for my tastes – they are limited by the provider’s data feed and proprietary programming, and they never include all of the things that might be important to me, based on long experience. And even if you can scan fundamentally for a long list of data points, that ability is not necessarily an advantage. Once one gets past company size, earnings quality and dividends, data points become increasingly less useful.

Besides, lists can be constructed that incorporate the really important data points that seasoned writers would include in a fundamental scan. For example, one might scan for mid- to large-cap companies by market capitalization. But a list of, say, stocks in the S&P 100, Nasdaq 100 or S&P 500 indices accomplishes the same thing, no? Lists of stocks on large stock indices also eliminate temporary high-fliers that become a mid-cap due to a bloated stock price.

For those covered writers who wisely seek companies that consistently grow earnings, even in rocky times, such a list is easily compiled and updated.

Some covered writers like to search for trade candidates featuring call strikes that are deeply in the money or out of the money. If the market is declining, for example, the more seasoned writers often are looking for high ITM returns that offer excellent downside protection. When a stock is rising in a rising market, writing OTM calls can be the most rewarding approach, because of the greater likelihood of being assigned.

The worst lists on the web are those that simply present the highest-returning trade candidates without further filtering. The very highest returns tend to be the riskiest, forcing the covered writer to carefully evaluate each stock. It saves time and energy if the filtering and sorting already has been done and you can confine your initial review only to companies that closely meet your goals.

Researching Trades

Achieving consistently successful results requires doing the requisite amount of analysis and evaluation prior to trade entry – and when considering a trade modification such as rolling the calls. Yet it is also important not to spend unnecessary time on the trade analysis process – that is, don’t waste time on trades that don’t cut the mustard. My personal analytical process is designed to disqualify poor trades and low-probability trades as soon as possible, so that no more time is wasted on them than absolutely necessary. For this reason, I tend to put the initial analytical focus on the deal-breaker factors. If they are not right, I waste no further time on the trade.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.