Best Stocks for Covered Call Writing

In a previous post, How to Make Money With Covered Calls, we introduced you guys to the concept of covered calls.

Now, the question we get most from readers is “Can you share some of the best stocks for covered call writing?”

And that's exactly what we're sharing in this article.

First, a refresher…

What is a Covered Call?

A covered call is a type of options trade.

An options contract (option) is an agreement between two parties to facilitate a potential transaction on the underlying security at a preset price, prior to the expiration date.

Options trading can be complicated and confusing.

And options aren't suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses.

But selling or “writing” a covered call is one of the least risky ways of making instant income with options.

A covered call is simply when an investor sells a call option on a stock that the investor owns.

A covered call has three main ingredients, the Stock, a call option, and an expiration date.

Options Vocabulary

There are two types of options: Calls and Puts.

A Call option (Call) is an option to buy assets at an agreed price on or before a particular date.

A Put option (Put) an option to sell assets at an agreed price on or before a particular date.

A Strike price (Strike) is the is the price at which the contract can be exercised.

An Options Contract represents 100 shares of underlying stock. So if an option is selling for $1.00, that means per share and you multiply it by 100.

And remember, a call or put give the owner the right to buy or sell, not the obligation.

Here's an Example…

Let’s say an investor owns 100 shares of XYZ stock. The current stock price is $100 per share. The investor sells a call option for $110. Assume the option premium is $0.65 or $65 per contract.

Scenario 1

XYZ stock trades below the $110 strike price and the option expires worthless. The investor keeps the $65 premium and his 100 shares of XYZ stock.

Scenario 2

XYZ rises above the $110 strike price. The option will be exercised meaning the 100 shares of XYZ stock will be sold at $110/share – a $10 per share gain – and the investor also keeps the $65 premium.

The covered call strategy is said to offset downside risk and add to upside return.

It will also cap the investor’s potential gains to a stock by selling away the upside as a premium.

One of the main goals of this strategy is to sell at a strike price just high enough to make a decent premium but low enough that your shares won't get called out and the option expires.

If all goes well, the investor gets to keep the premium and the stock.

This strategy is said to be most effective in a steady falling or flat markets.

This is a neutral strategy, which means the investor believes the stock will have minor increases or decreases.

This strategy shouldn’t be used by a ‘bullish’ investor or in highly volatile markets or stocks.

Performance

The following are funds that use covered calls as an investment strategy. (Buy-write just means that you buy the stock the same time you write a covered call.)

  • Invesco S&P 500 BuyWrite ETF (PBP)
  • Horizons S&P 500 Covered Call ETF (HSPX)
  • Recon Capital NASDAQ 100 Covered Call ETF (QYLD)
  • First Trust BuyWrite Income ETF (FTHI)
  • First Trust Hedged BuyWrite Income ETF (FTLB)

They represent funds with different total assets ranging from $11M to $370M and can give you an idea of how professionals perform using the strategy.

Here's how the funds yearly market performance compared the S&P 500.

best stocks for covered call writing

In the following table I have used the total return from each fund’s respective inception date.

I have compared each fund to the S&P 500 from the same date as the ETF inception date. Both returns assume all dividends are reinvested.

While it appears the S&P 500 drastically outperforms the ETFs in performance, it should be noted that the covered call strategy is not recommended in a bull market.

Most of these funds began during the long running bull market of the past 10 years.

As we head into a bear market, you'll see these funds do much better against these benchmarks.

So, What Are the Best Stocks for Covered Call Writing

Obviously the first place to start is with stocks you already own.

Our founding editor, Susan, routinely sells covered calls against her holdings generating extra cash flow of $300 – $1,200 a month.

If you don't have any suitable stocks to write covered calls on, experts suggest the investor stick to large-cap stocks with high liquidity.

The best stocks for covered call writing are those that the seller believes will have a large demand in the short term.

Sellers should look for stocks that possess the following traits when selecting the best stocks for covered call writing:

  • Have a neutral view of the stock or believe it will decline.
  • Pays a current dividend yield of 3% or more.
  • Has a recent history of strong share price growth.
  • Is in a sector that is expected to perform well in the near term.

I would stick with blue chip stocks, as those are in relatively high demand and usually don’t have sharp increases in stock price.

Here are 5 that fit the bill:

Prices are as of 1/25/19.

You can also check out Barchart's Covered Call Screener tool to come up with stocks that are suitable for selling covered calls against.

If you want to go deeper on this topic, join Income Investors Academy where we have several options courses including one on how to make money with covered calls.

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