By Steve Papale
Still July. Seems like summer has barely started, especially here in the Midwest. Been rainy and cool mostly. But maybe partly because of the lousy weather attention is beginning to turn toward football. Training camps start in a week. All the teams are undefeated right now. Even the Chicago Bears. So here’s to the perfect season. I’ll keep dreaming until opening day.
Selling high yielding calls for income can be a profitable trading strategy. OptionVue has a nice search feature called OpScan that can look for high yielding calls from the universe of stocks and ETF’s. But finding the candidates is only half the battle. Determining whether to place the trade or not is the other half.
Option yield is largely determined by implied volatility. And implied volatility (IV) is generated by the option markets perception of future risk in the underlying. For example, IV rises almost without exception ahead of earnings. For stocks where earnings are more uncertain, IV will rise more. Industries like biotech also are inherently more volatile and hence have higher IV and higher yields on options.
The point is this – the option markets don’t generally (pretty much never) give away free money. If yields are high than they are high for a reason, specifically options markets see higher than normal risk in the underlying. So look at the potential yields. That gives us a nice pool of candidates. But then take a look at why yields are so high and most importantly determine how the trade will be managed if it is put on. Again, it always come down to risk management. Selling options in high yielding environments can be very profitable. But always do the homework first and know where the exit doors are.