Covered Call Writing: The Significance of Volume and Open Interest

By Michael Thomas:For those of you who have never dealt with options before, the idea of using a covered call on a stock position you own may seem like a foreign concept. Let's first explain what an option is. In the most basic sense an option either gives you the right to buy ("call") or sell ("put") an equity at a determined strike price within a certain period of time. Options chains are displayed on just about every financial quoting website out there such as Yahoo and CNBC.

By Alan Ellman:Covered call writing requires a logical sequence of stock and option decisions. Once we have screened our stocks to locate the greatest performing stocks in the greatest performing industries we must make a decision as to which strike price to use. Our choices include:

By Alan Ellman: Mid-Contract Unwind: The major concern for covered call writers is the stock price dropping in value. The option premium collected is money in the bank. Most of our exit strategies are designed to mitigate these losses and turn losses into gains. However, as Blue Collar Investors, we should also be prepared to act if the opposite scenario occurs.

By Alan Ellman:One of the common flaws found in many of the studies of the covered call strategy is that they select only slightly out-of-the-money strike prices. Needless to say, a majority of covered call writers are also guilty of the same mistake. It is certainly understandable why one would lean to this strike as we ultimately will garner the very highest of

By Alan Ellman:What makes some options premiums worth so much more than others? Let's say we have two stocks, A and B. Both are trading @ $25/share. We look to sell the same month A-T-M $25 strike and one (stock A) returns 2% and the other (stock B) 4%. WHY? The answer lies predominantly in the mysterious world of implied volatility (IV). The volatility of an option reflects the fluctuation in the price of the underlying stock, both up and down.

By Alan Ellman:One of the most popular exchange-traded funds used by covered call writers is the Powershares Qqq Trust, Series 1 (QQQ). It consists of a basket of 100 of the largest non-financial stocks listed on the Nasdaq exchange. Most ETFs have a low implied volatility when it comes to selling options because they consist of numerous equities and the price movement of some offset that of others.

By Alan Ellman:I sell predominantly one-month options. This decision was NOT based on anything I read or was told, but rather on experience and common sense. Most stocks with options have at least four expiration cycles affiliated with them at any point in time…the current month, the next month and two more months further out based on the particular option cycle that particular equity has been assigned to. Stocks that also have LEAPS (long-term options) have more than four cycles.

By Alan Ellman:Innovative investors can develop ideas of implementing a strategy in unconventional ways. For example, we can invest in a money market or CD and perhaps not even beat the inflation rate with those dividends. We can buy a quality bond and wait six months to receive our first (ho-hum) return.