Covered Call Option Trading Strategy for Steady Income

Covered call writing is a relatively conservative option trading strategy that most people can employ. As a matter of fact, the U.S. government deems call writing to be a relatively safe trading strategy to use in a retirement account. And covered call options are the only form of option trading that is allowed in your IRA account. Likewise, many big institutional investors leverage covered calls to supplement income in their managed portfolios. With the right strategy an investor can conservatively earn from 3 to 5% per month by writing covered calls against the equities in the account.

At first blush, a 3-5% income per month doesn't seem like much. But when compared to earning a paltry 0.1% per month in a money market account, covered call writing suddenly becomes very attractive. To put things in perspective, a $5K account can potentially earn $150/month (assuming a conservative 3% income rate per month). In 12 months, the investor can expect to earn approximately $1,800 from the initial $5,000. That is a cumulative earnings potential of 36% per year. How does that compare to a 1% per year earnings rate in your savings account??

In many cases, a typical investor may have a basket of mutual funds, stocks and possibly ETFs in his/her retirement account that are not sold nor traded for many many years. When the stock market goes up, the investor reaps the benefits of the rising stock prices. However, when the stock market goes down, many of those same investors do not sell their stocks. Instead, they ride the market all the way down to the bottom hoping and praying that their "long-term" investment will soon rebound. Even for those "long-term" investors, the covered call option strategy should be a part of their trading toolkit. If those investors do not want to sell their stocks, they should write covered calls against those stocks, in order to offset the loss when markets turn down.

Obviously, utilizing covered call options without having a sound strategy will NOT make you successful either. You have to implement a disciplined trading plan with predetermined rules for entering and exiting trades. Your trading plan doesn't have to be perfect. There is no such thing as having a "fool-proof" trading strategy...You will NOT win 100% of the time. The key is to successful covered call options trading is maintaining discipline in your trading...know where your exit points should be in order to minimize your losses and to maximize your profits.

The covered call trading plan that we use is based on AJ Brown's covered call trading method. As part of his trading strategy,  the Williams %R indicator is used to determine entry and exit points. To put it simply, when the oscillator breaks above the 80% level, we will consider going long (or begin buying the stock). We will then write or sell covered calls against the underlying stock during the same trading day or the following day. More details of his strategy can be found at his website (tradingtrainer.com). There is much more to his strategy than the Wlliams %R oscillator. Brown goes into details on other factors that he uses for confirmation, including additional strategies to help the investor protect against the possibility that the stock might decline in price. His comprehensive strategy can be utilized to help minimize risk and maximize profits. He also makes it simple for the investor by packaging his strategy into a nice and neat trading tool. He calls the covered call trading tool the Black-box Trading System. The web-based trading tool automatically scans all of the stocks including ETFs to obtain the best covered call candidates. The tool and the covered call candidates can be accessed 24//7. In addition to stock scanning, the tool is also used to calculate entry/exit levels, profit targets, break even points and risk tolerance to enable the investor to maximize profits with minimum levels of effort.

Our trading group actually uses his trading strategy in conjunction with support/resistance levels and the Fibonacci Retracement Principle to help predict price movements. On a recent trade (refer to FAZ chart in figure 1), we went long and entered a position in FAZ on Tuesday, June 22 (as indicated by the green arrows). The green candle on that date also corresponds to the Williams %R confirmation rising above the 80% level. We are now waiting for our entry signal to sell the covered calls. We will base our decision on how FAZ approaches its 200-Day moving average, which currently hovers near the $20.30 price point. If and when FAZ breaks above its upper swing point (at $18.20) and subsequently, the 200-day moving average, then and we will evaluate the possilbility of selling the covered calls. On the other hand, if the stock is not able to break above its high swing point (at $18.20) or is unable to break above the 200-day SMA( with Willliams %R confirmation) or falls below the Fibonacci swing point at $13.6, then we will exit FAZ without ever getting into a call position. We will update this journal as time progresses.

Figure 1 - FAZ Entry Chart

Utilizing the covered call trading strategy will not make you rich. But if you want a conservative method of earning a steady stream of income per month, covered call options should be considered.

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On July 8th, we got our signal to sell covered calls against FAZ ( refer to figure 2). The williams %R fell below the 20% level as well as the price falling below the 200-day SMA. We sold 10 contracts of the August 19 calls at $1.35/share netting us $1350 before commissions.

Figure 2 - FAZ Covered Call Entry Chart