Selecting the Best Stocks to Sell Covered Calls

Jesse Anderson

Published on July 25, 2022

Picking the best stocks to sell for covered call strategies is an ongoing activity for investors hoping to draw income from an existing portfolio.

The most important aspect of any investment strategy might be stock selection. Not all stocks will make good covered call candidates.  For example, a stock that you believe will increase in price significantly would make a poor covered call stock.  We encourage investors to use stocks with strong fundamentals.  Using companies you believe are a good long-term hold makes your covered call income the boost you need to outperform. 

As with most financial decisions, your personal investing goals determine the best covered call stocks for you. Let’s look at some typical ways to pick the right stocks for covered calls. We’ll also learn about some tools to help simplify and speed up the process of screening for stocks.

Covered Call Stock Picks for Long Investors

A covered call is a popular strategy to generate income from stocks whose prices investors think are unlikely to rise much further in the near term. A logical place for long investors to start may be to write covered calls on stocks from companies with relatively stable prices they already own or wish to own.

Remember when you sell a call option, the buyer pays the premium upfront, which you keep regardless of what happens with the stock. You won’t gain any upside beyond the strike price, and the premium income will offset some of your losses if the stock falls. Stocks with low volatility represent less likelihood for both large up or down price movement.

Be aware of your timing when writing a call option, even with a long-term hold. Upcoming dividend and earnings dates can lead to increased volatility.  It is preferable to avoid the situation where the call option moves into the money and you may have to either buy back the option or give up the stock, which may have a tax consequence.

Stock Picks for Income: Using Covered Calls

Retirees using their portfolio to support their living expenses are often concerned with pulling income out of their portfolios without selling the stock. Maximizing income potential when writing call options can support higher withdrawal rates translating into more money to live. For this reason, they typically perform more research and juggle more variables when making their picks.

A common strategy that traders use when seeking the best stocks for covered calls is to take a closer look at volatility as an indicator. They try to get a sense of the current market sentiment compared with past volatility.

Market sentiment is interesting because it refers to the psychological factor in the markets and tends to reflect the overall market performance. As you might expect, market sentiment is bullish when prices are rising and bearish when prices are falling.

In an industry dominated by data, traders use a couple of market sentiment metrics in an attempt to quantify subjective influences. Income investors compare implied volatility (IV)—a proxy for market sentiment—with historical realized volatility (HV).

When implied volatility generally runs ahead of historical volatility over a given term, covered calls on the stock generate an abnormally high level of income. Traders also take into account adjustments for earnings, dividends, or other factors that can influence volatility.

Two more metrics that help traders with risk-reward tradeoffs are downside protection and if-called return. The if-called return is the return that you’d realize if the call option holder calls the stock. The downside protection is how much the option premium offsets losses in the underlying stock.

The challenge for investors is to capture an overall view of the different metrics in a way that allows them to quickly compare different stocks. Luckily, today’s investor has tools at their fingertips that investors just a few years ago could not access.

Tools To Simply Picking Covered Call Stocks

Depending upon your investment strategy, picking stocks requires an overall sense of market movements and stock-specific granular metrics.

The good news is that tools exist to help you do just that. The OptionDash stock screener has a clear, easy-to-use interface that is purpose-built for buy-write and covered call strategies.

Users can set criteria ranging from market cap, various fundamental ratios, and optionDash’s proprietary scores. This unique scoring system has three values: Value, Trend, and Quality. Each score helps you determine important attributes many investors consider including the valuation situation of the underlying stock, whether it’s trending higher or lower, and even the potential risk of bankruptcy. OptionDash also has a powerful sorting function to sort by all the common covered call metrics including  if-called returns, downside protection, and more. Investor intel like these metrics can save you time and may help improve your outcomes. You can easily familiarize yourself with the interface by getting started for free!

Finding the right stock to buy for a covered call strategy is a critical first step, but there is more to covered calls than picking a stock and selling a call option. Investors need to decide on allocations, strike prices, and expirations. If you are looking for an experienced approach to buying stocks from well-run, solvent companies to generate options income, the Snider Investment Method®, offers a roadmap.  They even offer a free course, Stock Selection 101, to get you started.

Snider Advisors also created Lattco, a proprietary software tool, and platform that makes it easy to execute trades automatically, generate portfolio reports, and ensure that you have the right level of diversification.

The Bottom Line

For investors new to covered call strategies, picking stocks may feel confusing at first. Sometimes the best approach is to go slow now to move faster later. In other words, spend time learning the fundamentals. Familiarize yourself with the online tools for covered call investors.

Resources such as Snider Advisors’ free courses can also help you learn the fundamentals. Tools such as optionDash and Lattco can help save time and compare stocks to make better choices.

If you’d rather avoid the time and effort of finding opportunities, Sinder Advisors provides a done-for-you solution via their asset management services. Contact them for a free consultation to learn more.