How to Select the Best Covered Call Writing Strikes in Bear & Volatile Markets – October 24, 2022
Option selection is the 2nd of the 3 required skills for achieving the highest possible returns when writing covered calls or selling cash-secured puts. Option decisions include strike and expiration date choices. This article will focus in on strike selection for covered call writing in bear and volatile market where we take defensive positions that will still yield significant returns. A real-life example using Jabil, Inc. (NYSE: JBL) will be highlighted.
Explanation of defensive covered call writing positions
We favor in-the-money (ITM) call strikes in challenging market environments. These strikes have 2 components: time-value + intrinsic-value. At-the-money (ATM) and out-of-the-money (OTM) strikes only have time-value components. This means that ITM strikes offer greater protection to the lower breakeven price point. So, we start with a conclusion to favor ITM strikes when deciding on the moneyness of options (ITM, ATM or OTM) in bear and volatile markets.
The other major factor when selecting strikes is to make sure the time-value of the premiums align with our stated initial time-value return goal range (2% – 4% per-month, for me). We can divide a monthly goal by “4” when using weekly options.
Real-life example with JBL ($59.17): Option-chain on 10/14/2022 for the 11/18/2022 expiration
Let’s assume a goal of 2% – 4% per-month as our guideline. We then check the current option-chain.
With JBL trading at $59.17 0n 10/14/2022, we will evaluate the $45.00, $50.00 and $55.00 ITM strikes. We will use the published bid prices of $14.20, $9.30 and $5.40. Members of our BCI community should always leverage the Show or Fill Rule to negotiate better prices when such opportunities present.
Initial calculations and exit points using the BCI Trade Management Calculator
Note the following:
- Only the $55.00 strike meets our stated goal of a minimum initial return of 2% as highlighted in the brown cells (goals can be adjusted in either direction … there is no right or wrong)
- There is never upside potential when using ITM call strikes as we are agreeing to sell the shares at a price lower than current market value
- The $55.00 strike offers an initial 36-day time-value return of 2.24%, 22.67% annualized
- This 2.24% initial profit will be realized if share value does not decline by more than 7.05% (downside protection) by contract expiration
- The exit price points are highlighted by the blue arrow at the bottom of the screenshot (for exit strategy intervention)
- The red arrows at the top of the screenshot shows that the ex-dividend date is prior to contract expiration. If it is critical to avoid exercise, this trade should be avoided. This may apply if trading in a non-sheltered account with shares of a low cost-basis and concerns of negative tax consequences. Typically, if we don’t want exercise of the call option, we would avoid ITM strikes
Discussion
When selecting the most appropriate covered call strikes in bear and volatile markets, we must factor in the moneyness of the option (ITM) and the initial time-value return offered by that strike. Using standard option-chains and the BCI Trade Management Calculator will facilitate these decisions.
Author: Alan Ellman