To find a covered call deal using our data, start with the tables on the Data Menu. You must be a subscriber to access the tables of current high-yield covered calls. You can see a table of older data at the Sample menu line of the Main Menu. (It would be a good idea to print the first page of the Sample data so you can refer to it while you read the following text.) There are three tables of calls for the current month and three tables of calls for the next month.
The table of "In the Money" calls has the safer, more conservative deals. They will typically have lower yields but have the most down-side protection if the price of the underlying stock goes down.
The table of "Out of the Money" calls will have riskier deals that may have higher yields. The table labeled "All" combines both In the Money and Out of the Money calls in one table. All the tables are sorted based on the sort order that you choose in your Preferences file.
The first column shows the yield of the deal if the call is not exercised. The second column shows the yield of the deal if the call is exercised. The third column has the option symbol; if you click on the option symbol, you will hyperlink to a page at Yahoo! Finance that will show slightly delayed pricing and other data about the option. If the market is closed, the data will be the closing data for the day.
The fourth column shows the symbol of the underlying stock; if you click on the stock symbol, you will be taken to the charting web site that you have chosen or set up in your Preferences file. The chart screen will show historical prices of the stock for some period (the default is usually one year) as well as default or custom indicators based on the pricing data shown.
There are two broad types of data usually used to analyze stock prices. Fundamental data is the core business data that shows the health of the company. Such things as earnings, profit or loss, return-on-investment, and price-to-earnings ratios are some of the fundamental data that investors use to decide which stocks to buy for their portfolio. Technical data consists of the historical prices of the stock for various time segments and the chart patterns and various mathematical indicators derived from that price history.
The fundamental data shows the performance of the company over time. Investors buying and holding stock long term (many months to years) use it to try to figure out how the company will perform in the future. Short term (minutes to a month or two) traders (which most covered call writers are) use technical data to chart the reactions of all other traders as reflected in the short term price fluctuations of the stock. While the fundamental data is relevant to covered call writing, the technical analysis of the stock is more useful to traders of covered calls.
Technical analysis is used to attempt to predict the likely price fluctuations of the stock over the month or two that a covered call deal will be in place. Price charts are the lifeblood of the covered call writer. In-depth coverage of the many facets of technical analysis literally fills hundreds of books. Fortunately, you can get started writing covered calls with an understanding of a few basic concepts and then refine those skills for a lifetime if you choose to do so.
 | Technical analysis starts with data on a special type of bar chart designed just for pricing data. [There is a second chart design called "Candlestick Charts" that some use that is similar; see this link] The price bar describes trading action in a security (they are used for more than just stocks) for a given period. We will use a daily price bar since that is what you will most often use, but the bar is constructed the same no matter what time period it is for. |
The price bar consists of four components that are depicted with three lines. The "bar" is a vertical line that starts at the lowest price for the period and is drawn upward to the highest price for the period. The bar is placed on a two dimensional graph where the horizontal axis is the time period (such as days) and the vertical axis is the stock price. There is a short horizontal line (called a tick) on the left side of the bar that is placed at the opening price of the stock - the price of the first transaction during the period. There is a tick on the right side of the bar that is placed at the closing price of the stock - the price of the last transaction during the period. In the case of a daily chart, there would be one bar for each day for however many days the chart has been drawn.
The daily price bar shows the effects of every factor in the market for the specific stock that day, including:
The price bar tells you the outcome of the struggle between the buyers (bulls) and the sellers (bears) of that stock on that day. If the price opened at the low and closed at the high, the winners that day were the buyers. If the price opened at the high and closed at the low, the winners that day were the sellers.
The bar depicts a very real contest that is measured in money. If the bar is very tall, encompassing a range of $10 when the normal bar is only $3, then the battle was fierce. If the bar is short, say $1, then the battle was cream puffs at three paces.
The relationship between prices and volume (the number of shares or contracts traded during the period) is important. Everything that you infer about the state of mind of the market must be confirmed by volume. A lot of volume on the aforementioned $10 day would confirm a big battle. But a $10 dollar day with a single trade would just mean that somebody made a mistake. Some buyer screwed up or the data collection department at the exchange got the data wrong.
The opening price is related most closely to the closing price of the day before. If the open is up from the previous close, you can imagine that the first trader of the day is expecting favorable news or has some other reason to believe that a purchase at the higher price will result in a profit. The first trade sets the tone. Some times the higher opening is due to a practice called "buy on open." Mutual fund managers or other professionals may have gotten new money in the night before and have it allocated to specific stocks. A "buy to open" is the easiest way for them to top up their fund and not necessarily a judgment of the specific stock on that day.
If the opening price is below the close of the day before, chances are the tone is bad. It may be that bad news of some kind came out after the close.
It is also possible that the opening price means nothing at all. It may be that Joe Investor simply decided that it was time to buy the boat he has always wanted and so is cashing stock to fund that purchase. That is unlikely to happen several days in a row, however, so several days openings taken together can be a good gauge of opening sentiment.
The close is considered the most important part of the price bar. The close summarizes what traders feel about a stock. They have watched the price action of this stock all day and have a sense of how popular it was near the lows or how unpopular it was near the highs. As the close nears they must decide if they are going to hold the stock overnight. They only do that if they think it will go up tomorrow so that they can't buy it more cheaply than they already have.
If today's close is consistently higher than yesterday's close, day after day, then buyers are demanding more and more of the stock and are willing to pay higher prices to get it. If each days close is lower than the last then sellers are taking ever-lower prices to get rid of the stock. The stock is on sale.
The high of the day has meaning only in its relationship to other parts of the bar, especially the close, and to the high of the day before. When the price closes at the high of the day, traders are extremely optimistic of more gains to come. When the high is at the open and it's all downhill the rest of the day, traders are pessimistic.
The low also has meaning only in context of the other parts of the bar. When the low is lower than the open, it probably means that some fresh news has come out after the market opened. When the close is at the low, the bad news ruled for the day.
When you look at a series of bars, you get even more information. You may get more information that you can handle. The central observation of technical analysis is that the price bar embodies all the supply-demand dynamics of the day and that a series of bars on a chart shows the evolution of the supply-demand dynamics over time. Some percentage of the time, the evolution is visible in the form of a trend. The trend is your friend if you can identify it.
The textbook-perfect uptrend is a series of price bars that have higher highs and higher lows than the day before in a majority of the bars. The textbook-perfect downtrend is a series of price bars that have lower lows and lower highs in most of the bars. A new high or low makes the market nervous. A sufficiently large number of new highs trigger the greed instinct - better buy now so you don't miss out. The result is a higher close as buyers pile in near the end of the day. New lows scare enough traders that they sell their positions. Sellers are unwilling to hold a falling stock and sell near the end of the day, causing a lower close.
Covered calls work best on stocks that are trending sideways or up so identifying such trends helps us decide which deals to go into and when to stay in or exit deals when the stock is going down.
Identifying trends and reading bar charts is more art than science. Two people looking at the same chart can read different things into it. Indicators are the scientific answer to that problem. Many very smart people have used math and statistics in creative ways to reduce chart information to a simpler indicator of what is happening in the market. There are a large number of indicators to choose from. Some help you identify buy-sell points. Others are used to confirm those buy-sell points since no indicator is correct all of the time. It is best to use two or three together to have the best chance of correctly forecasting the price moves of the stock you are interested in.
The following discussion will show one way to use indicators to determine which covered calls to write. There are other combinations that will also work. A large part of your learning is to figure out which ones work best for you. We recommend Technical Analysis for Dummies by Barbara Rockefeller for a more detailed discussion of this subject. When reading books on technical analysis, remember that they are written for traders that actually buy and sell the stock when the technical triggers indicate that they should do so. The buy and sell points may happen in the same day. Covered calls, however, are stretched out over the life of the call. We can't sell the stock at a sell trigger unless we first buy back the call. We use technical analysis to try to predict both the direction and size of price moves in the stock rather than the specific points to buy or sell.
It makes sense that we wouldn't want to sell a call whose stock has just triggered a sell indicator. If the market forces are driving the price down, the loss from the stock is likely to be greater than the gain from selling the call come expiration day. It does make sense to sell a call whose stock has just triggered a buy indicator. If the stock price at expiration is more than we paid for it, we may make that gain as well as the money we made selling the call.
To determine those buy-sell points we use two moving averages. Moving averages are the draft horses of technical analysis. A moving average is an arithmetic method of smoothing price numbers so that you can see and measure a trend. A moving average clings to the prices but at the same time smoothes away the occasional erratic price. You can determine how much smoothing you get by varying how many days you average over.
When the price is moving upward or downward, so is the moving average line. When the price direction changes, the price will cross the moving average line. The general crossover rule is that you buy when the price crosses above the moving average line, and sell when the price crosses below the moving average line. Unfortunately, the price doesn't always stay across the moving average line. Often it will jump back across the line for a day or two before resuming the new trend. Or it may just stay across the line and resume the original trend. If you use the crossover rule to buy and sell, you get a lot of buy-sell signals that reverse quickly and you spend all your gains paying commissions to your broker. The false signals just described are often called whipsaws.
One way to smooth the moving average to reduce whipsaws is to lengthen the number of days in the average. Because of the way it is calculated, a moving average always lags the price action. So using more days in the calculation means the buy-sell crossovers will come after the actual reversal of the trend. You many, in fact, miss most of the new trend while waiting for the crossover. The fewer the days used in the average the shorter the lag.
Another way to make an average more responsive to the latest prices is to weight the latest prices more heavily. You get a weighted moving average by multiplying each price in your series by a number reflecting how fresh it is. In a five day moving average, day 5 (today) would be multiplied by 5, day 4 by 4, etc. You then divide the total by the sum of the weights to get the average.
A similar, more popular, and more complicated method is an exponential moving average. It is a bit difficult to calculate, but all the charting software does it for you.
It turns out that you can use two moving averages calculated with different numbers of days and the crossover of the two lines is a good indicator. The charts we use will have an exponential moving average (EMA) using 5 days (week), and an EMA using 20 days (month). When the shorter average crosses above the longer average you should buy and when the shorter average crosses below the longer average you should sell. Since no indicator yet invented is correct 100% of the time, we look to other indicators for confirmation of the signal.
One way to confirm buy-sell signals is with a momentum indicator. "Momentum" is a word used to describe the rate of change of an object. In this case the object is the price of a stock. Momentum is a leading indicator and can be used to offset the lag of moving averages. Momentum can be used to indicate when a stock is overbought or oversold. Overbought and oversold are terms specific to securities trading. When a price has reached or surpassed a normal limit, it is at an extreme. In an upmove, everyone who wanted to buy has already bought and the market is called overbought. In a downmove, everyone who wanted to sell has already sold and the market is called oversold.
Momentum indicators measure the rate of change of the price of a stock. It makes sense that you would want to buy a stock when the price is accelerating to new highs and get out of the stock when the price is accelerating towards new lows. Covered calls work just fine when the price is neither accelerating or decelerating as depicted by a mid range momentum line or when the line shows an oversold condition.
Our momentum indicator of choice is called a Relative Strength Index (RSI). The RSI maps to a scale of 0 to 100 and normally varies between 30 and 70. When RSI is at or above 70 the stock is considered overbought and any other sell indicator is confirmed. With RSI at or below 30 the stock is oversold and any other buy indicator is confirmed.
A third type of indicator is based on volatility which is a measure of price variation. Volatility refers to the extent of variation in the price, either the total movement between low and high over some fixed period of time or variation away from a central measure like a moving average. Like everything else in technical analysis, it is useful to think of volatility in terms of crowd sentiment. Volatility will be high when traders are excited about a new move. High volatility means trading is riskier but has more profit potential, while low volatility means less immediate risk. Low volatility usually precedes a breakout.
The volatility indicator most traders use is the Bollinger band, named for its inventor, John Bollinger. He charts a simple 20-day moving average of the closing price with a band on either side one standard deviation from the moving average. Conventional statistics says that two standard deviations capture 95% of the variation. The bands are effectively moving standard deviations.
When a price touches or slightly breaks the top of the band, you have a continuation of the trend signal. Often the price will continue to walk up or walk down the band. As volatility slows and momentum falters, the price bar stops hugging the band and slides down to the moving average line or lower. When prices break through the moving average other buy-sell indicators are confirmed. A sideways move is usually indicated by a narrowing of the bands. Traders are having second thoughts. They aren't willing to spend money to test a new high, but they aren't willing to sell either and thus new lows don't appear.
So let's put all the indicators together and see what we have so far.
The only other piece of data that we should see is the volumes. We'll add that at the bottom and have a complete picture of our stock. Remember that prices must have some volume to be true indicators of the day.
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