Best Stocks For Trading Covered Calls

If you’re considering a covered call trading strategy, what stocks are the best ones to select?

Here, we will uncover the characteristics of stocks that make for selling premium possible on an ongoing basis in order to generate income on a predictable time schedule.

There are a few other key characteristics that a stock needs to possess in order for it to make a good covered call candidate, so let’s highlight them first.

Are Volatile Stocks Good For Covered Calls?

A covered call strategy generates higher returns when share price are volatile which leads some new investors to get tempted by high monthly premiums.

You can think of this approach as being akin to buying a dividend stock with a high yield. It’s often quite lucrative but there is a substantial risk of share price losses offsetting yield gains.

History is fraught with examples of companies with poor balance sheets that are heavily indebted paying lofty dividend yields for short periods, only for the Board of Directors to pull the rug out on shareholders and cut the dividend to shore up the balance sheet. Inevitably, the share price plunges as the incentive to hold the stock no longer exists.

Similarly, a highly volatile stock has the potential to generate handsome returns by selling call premiums but a fast moving share price can more than offset the gains from selling premiums when volatility spikes occur.

For the speculator, a volatile stock may work well, and especially if the trader is more skilled at market timing, but for most investors the slow and steady stock with a tendency to rise over the long term is a better bet to squeeze out reliable call premiums.

So, what stocks fit the bill?

Best Stocks For Trading Covered Calls

The best stocks for trading covered calls have wide moats, strong cash flow generation and a track record of steadily rising over the long-term.

Apple is a good example of a stock that has demonstrated these characteristics over the long haul.

Consider a recent example that highlights the principles of covered call selling that matter most.

Of course, Apple will have upswings and downswings but over the long-term the trend has been higher. That’s a function of the company’s wide moat that protects it from competition and ensures it can grow predictably. 

With the stock trading at $185.54, a covered call seller can select the 190 strike call in December of 2024 for $16.70 per share.

The cost basis of this position, if newly established, is the cost of the stock minus the call premium, so $168.84.

If the stock falls over time, the covered call seller will lose money on the share price decline but enjoy a profit, most likely, from the call going lower in price.

In a best case scenario, the covered call expires worthless and the full $16.70 per share is captured, translating to $1,670 per call contract.

Source: tastytrade

If the stock rises in value, and trades higher than the call strike price of 190, the obligation of the call means that the stock will be sold at $190 per share. So, the maximum profit in the trade is the difference between the call strike price of 190 and the cost basis of $168.84, which is $21.16 per share.

The maximum return on risk is then 12.5% over the duration of the trade. For investors who are conservative-minded, that’s a pretty good number over the course of about 10 months. But it can be improved upon.

Note that the July options, which expire in 157 days versus the December ones expiring in 311 days pay the call seller $9.70 per share.

Source: tastytrade

So why choose the July options over the December ones? 

If the expectations are for the stock to stay flat, fall, or rise but only a little, the higher call premium in December offers more downside protection.

Equally, the July options would be preferred if the expectations are for the stock to continue its march higher because the potential to capture a higher rate of return exists.

Source: TradingView

In general, selling call options over shorter durations will lead to higher rates of return than over longer term time horizons, but it’s important to ensure the share price is trending generally higher to capture these gains from both the stock price rising and the short call expiring.

If an expectation for a larger pullback exists, then it’s better to place the call options further out in time in order to better cushion against the blow of a larger downdraft.

Stocks That Are Good For Trading Covered Calls

Similar to Apple, some other stocks that are good for trading covered calls include Microsoft, Meta, and Amazon.

Each of those companies have wide moats and long-term higher price trajectories that facilitate regular covered call premium selling.

History has shown intermittent, yet material, downswings in these stocks such as when Meta was widely believed to have made a strategic mis-step by deploying billions to its metaverse development. Over time, though, Meta share price bounced back and has continued to forge higher.

Similarly, Amazon and Microsoft have had drawdowns over short time durations and rebounded to higher highs each time over the long-term.

It’s that long-term focus which covered call sellers need to focus on. Specifically, the sum of premiums over time is what leads to large wealth accumulation. On any given day, week, or month, the premium from a single call sale is often not material but the total premium sold over a year can be substantial.

Take the Apple example above where almost $10 could be sold over a 5 month period. With the stock trading at just over $180 per share, it would take about 18 five month periods to reduce the cost basis on the overall trade (stock plus the sum of covered call sales) to zero.

On the one hand, that might seem like a long time frame of 7.5 years but if you could double your money every 7.5 years you can quickly do the math on how that would grow your wealth. In 7.5 years, $100,000 turns into $200,000. In 15 years, it turns into $400,000 and in 30 years it turns into $1.6 million. We’re assuming a Roth IRA or equivalent tax-advantaged account.

Dividend Stocks For Covered Call Selling

Another approach favored by conservative-minded investors is to sell call options on dividend-paying stocks. 

This method allows for income generation from two sources, quarterly dividend payouts and call sales. 

If it can be done on a stock that is undervalued fundamentally, it can be a highly lucrative strategy allowing for three means of profitability, including share price gains too.

A company like Verizon paying a dividend north of 6% is a prime example of an income-paying stock that could be targeted because the company has a strong track record of paying quarterly distributions to shareholders, as well as a history of increasing that dividend, and pays a modest call premium.

Dividend stocks are typically not a very exciting way to earn a lot of income in a short time frame but they do offer a means of consistently generating income without a whole lot of surprises, such as may come from selling calls on a more volatile stock, like Palantir.

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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.