Best Stocks for Covered Calls to Generate High Profit

Overview

The purpose of this article is to discuss where to look for the best stocks for the covered call strategy. This allows us to increase our income thanks to the premium we collect from the covered calls. We also give you an example list of stocks that could work with this technique.

Contents

How Do You Select Stocks to Sell Covered Calls?

Covered calls are a popular way for long-term investors to profit from their stock portfolio. A long-term portfolio may include Apple shares, for instance, and the owner could boost the return by writing covered calls. The best equities for covered calls are the ones you actually want to buy long-term. By selling a call option, you give up any potential profits above the option’s strike price but keep the premium. If the stock price drops, your premium income can help cushion the blow.

There are certain short-term investors who employ buy-write methods for the sole purpose of generating income. In other words, they choose the stock they want to buy based on how much money they could make by writing the call option. Finding the right stocks and options to use in this strategy will require additional analysis. The risk is much higher in this situation. Nonetheless, a good rule of thumb is to sell covered calls on equities you would like to hold. Ideal candidates are companies that have been profitable for a long time, have solid evidence of growth, and pay dividends. 

What Type of Stock Is Best for Covered Calls?

Investing begins with picking solid businesses to invest in. They shouldn’t be market darlings or prone to wild swings in stock price. They should be consistently profitable, demonstrate year-over-year growth, and ideally pay dividends.

This strategy is most effective with stable stocks. Although volatile stocks may offer higher premiums as a result of increased implied volatility, they are notoriously difficult to manage. In all likelihood, the stock options will be exercised and called away. Alternately, when the call option expires, investors will suffer huge losses.

List of the Best Stocks for Covered Calls in 2023

These businesses have a history of sustained profitability, year-over-year revenue growth, and dividend payments. Their share prices are also not very volatile.

Acadia Healthcare Corporation (NASDAQ: ACHC)
ConocoPhillips (NYSE: COP)
Devon Energy (NYSE: DVN)
Ford Motor Company (NYSE: F)
Johnsons and Johnsons (NYSE: JNJ)
Oracle (NYSE: ORCL)
PepsiCo Inc (NASDAQ: PEP)
Pfizer Inc. (NYSE: PFZR)
Verizon Communication (NYSE: VZ)
Walmart (NYSE: WMT)

Tips for Selecting Stocks for the “Poor Man’s Covered Call”

The “poor man’s covered call” strategy consists of buying and selling two separate call options. The advantages of this approach include a lower initial investment. Buy an in-the-money (ITM) call option with a longer expiration and sell an out-of-the-money (OTM) call option with a shorter expiration to establish a poor man’s covered call. The deep ITM call with a longer expiration date functions similarly to a long stock position due to its high positive delta.

Selecting a reliable stock for the “poor man’s covered call” follows the same principle. Successful candidates have shown a record of profitability, consistent year-over-year growth, and a history of improving dividend payments.

What Happens if the Stock Price Falls?

If the value of your stock declines, a covered call can help offset part of that loss. Its premium makes up for the loss in value of the stock as its price goes down. However, if the stock falls more than the premium received, the covered call strategy may begin to lose money. 

When Should I Take Profit on Covered Calls?

If the stock price rises above the strike price, the covered call trade will be most profitable. However, the stock may be called away if it’s higher than the call’s strike price as the expiration date approaches. An investor must decide whether to roll the covered call to keep the stock. Otherwise, the investor can let the shares be called away and realize a profit.

When the stock price falls below the call’s strike price, the covered call expires worthless. The investor gets the full amount of the premium and moves on. It is an option to sell another covered call and collect the premium.

When Should You Let a Covered Call Option Expire?

In general, it is advisable to let covered call positions ride until expiration if they are profitable. This is based on the premise that share prices are relatively stable. The stock price is somewhat lower than the call’s strike price at the expiration of the covered call. However, there are times when it makes sense to close off transactions early or roll a covered call to reduce exposure to risk or free up capital for other opportunities.

Is It a Good Idea to Buy Back a Covered Call?

When the stock price rises over the covered call’s strike price, the assignment risk increases. As a result, you can consider buying back the covered call to avoid having to sell the underlying stock. You can also roll the covered call to extend your time horizon and hope the stock price drops below the new call’s strike price.

Do You Get Dividends from Covered Calls?

The covered call technique can increase profits in declining or flat markets, but it caps gains during uptrends. Covered call writing is often done on dividend stocks. As a result, the shareholder not only receives the dividend but also potentially avoids financial loss in the event of a decline in the stock price on the ex-dividend date. 

Summary

In addition to providing some downside protection, covered calls can also generate revenue for investors in neutral to bullish market conditions by selling the underlying stock at a premium to its present price.

Covered calls are a powerful strategy that, when implemented correctly, may yield significant returns. The upside is limited, however, so they aren’t always the best strategy to use.