Covered Call Writing Strike Selection in Bull, Bear and Neutral Markets: A Real-Life Example with Crocs, Inc. (Nasdaq: CROX) – March 28, 2022
Covered call writing strike selection will vary from investor-to-investor. There is no single parameter that will guide us to the most appropriate strikes for our portfolios. Factors that must be considered are personal risk-tolerance, initial time-value return goal range and overall market assessment.
Personal risk-tolerance
The type of underlying securities we use and the “moneyness” of the strikes play a major role after determining the degree of risk we are willing to accept. Those with extremely low risk-tolerance will favor low implied volatility stocks and ETFs and in-the-money (ITM) strikes. More aggressive investors will incorporate higher IV securities and add in out-of-the-money (OTM) strikes.
Initial time-value return goal range
The higher the potential returns, the greater the risk. We must establish this range prior to entering any of our option-selling trades. My preference is to have an initial time-value return between 2% and 4% for monthly contracts. This is the range I will use for this article.
Overall market assessment
- Bear markets: Favor ITM strikes which offer greater protection to the downside.
- Neutral markets: Favor near-the-money strikes which generate the highest initial time-value returns with little or no downside protection of that time value profit or upside potential.
- Bull markets: Favor OTM strikes which offer 2 potential income streams, one from option premium and the other from share appreciation up to the strike price.
CROX option-chain with CROX trading at $153.66 on 10-22-2021 (29-day return)
- Yellow: $145.00 strike (ITM)
- Brown: $155.00 strike (near-the-money or slightly OTM)
- Green: $160.00 strike (OTM)
CROX calculations with the BCI Elite Calculator
- Yellow: Initial return on option (meets our 2% – 4% criteria)
- Brown: Upside potential (share appreciation potential in bull markets)
- Green: Downside protection of the initial time-value profit (intrinsic-value protects time-value in bear markets for additional protection to the downside)
Discussion
Strike selection is as much an art as it is a science. We must first establish our initial time-value return goal range. From there, we factor in personal risk-tolerance and overall market assessment. With these factors considered, strike selection will result in a well-thought-out plan.