STRATEGY AND FUNDAMENTALS
When it comes to covered call writing, I'm looking to leverage my holdings by extracting additional income on a regular basis. I look for opportunities of strength when engaging in this type of trading particularly after a significant move up after earnings or any news that lifts the stock. I allow myself enough of an upside buffer built into the strike price to potentially realize more appreciation in the stock while collecting a premium. This allows continual value extraction for residual income while decreasing the average share price. Over the long-term this can make a meaningful impact on overall returns while mitigating risk for a given stock.
Cash Covered Puts:
In addition IV Rank and probability (discussed below), when it comes to put selling (e.g. willing to buy shares at an agreed upon price by an agreed upon date while being paid a premium), I search for opportunities in high-quality names typically in the large-cap space that have sold off due to largely extraneous factors unrelated to the fundamentals of the company itself. I focus on companies that are growing revenues, possess great growth potential, have an acquisitive mindset while returning value to shareholders via paying out dividends and buying back its own shares. There are exceptions to this rule for high-growth stocks that can provide great returns in the options market. Typically, I look for a correction in a given stock due in large part to extraneous factors (i.e. political backdrop, weak foreign data, currency issues, etc.) or a narrow earnings miss. This is were I'm willing to "buy" high-quality names at 52-week lows via an option contract in hopes of a rebound in order to net a realized gain without owning the underlying stock. If assigned then I own a high-quality name which was purchased near a 52-week low.
IV Rank and Probability:
IV Rank and probability are key components when it comes to option trading. I typically sell covered puts when IV is high, IV Rank is > 50 and the strike price is 1 standard deviation out-of-the money. This set-up allows rich option premiums that will historically revert back to its mean resulting in volatility implosion which translates into decreased option prices. Once the contract decreases in value then I can elect to buy-to-close and capture a realized gain with ~84% probability of success since the trade was placed at 1 standard deviation out-of-the money.
The vast majority of the time I apply my 50% rule when closing out any option contracts thus if my option has reached the 50% threshold of maximum profit then gains are realized. Upon receiving premium income for selling a put option, once the contract declines in value, I buy-to-close the option contract early in the option life cycle. Accelerating the closure of the option contract will free up these funds for additional moves and lock-in realized gains. Often times value isn't added in waiting to realize that additional 50% of the contract value. If the underlying stock moves against you late in the contract life cycle then that extra 50% could be wiped out and possibly jeopardize the entire unrealized gain. For example, if I sell a put option for $1.00 per share and the contract is now worth $0.45 per share, I initiate a buy-to-close for $0.45 and walk away with a realized gain of $0.55 per share or $55 for the contract to capture 55% of the premium.