In my last post we defined exactly what a "covered" call is, plus what it means to "write", or sell one. With today's post, now we dig into the practicalities -- various things you may not be thinking of as a new options investor, but should keep in mind as you proceed.

Hopefully these tips will make your entry into covered call writing and options investing smoother and more informed, not to mention more successful.

Tip 1: Keep volatility -- likeliness of stock price movement -- in mind.

Writing covered calls works best on stocks with medium volatility, stocks that move but in fairly predictable ways. If volatility is too low, the premiums you'll earn will also likely be very low. If volatility is high, your chances of forfeiting your stock position also rise, but that's just the beginning. Don't forget that high implied volatility levels give you no hint as to direction; they only indicate that the stock is likely to make a big move in either direction. When you sell a covered call on a high-vol stock, you're accepting limited upside, but still have considerable risk on the downside. You're still long stock, so big drops in price can seriously hurt that position - a tradeoff for a premium that you may be sorry about later.

Aim for medium volatility -- attractive for call buyers, pushing up the premium price you earn, but not as unpredictable as high-volatility stocks.

Tune in soon for tip 2: handling the occasional surprise of getting assigned.

Regards,

Brian (OG)

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

First of all I want to appreciate your deciphering option instruments in layman's term.

How do we know a stock has a medium , low or high volatility? Is there a percentage rule that can be applied when comparing IV against HV?

Thanks

Great question, Jey. Here's a rough guide for the volatility ''sweet spots'' I look for on one-month covered calls that are currently ATM (at-the-money):

Price of stock Implied Vol.

100 - 20%
50 - 25%
20 - 30%

If you go even further out in time, it's fine to consider stocks with lower implied volatility. The added time value will increase the premium to an ''acceptable'' rate, but this obviously means you might be in the position longer than originally planned. Just weigh the trade-offs before proceeding.

If you do opt for larger implied volatility, the downside risk of owning stock is big - I can't emphasize this enough. Investors get enticed by the high premiums they can earn on options with higher IVs, but often they don't realize that high implied means the stock is just as likely to go down as it is to go up. On the upside you are okay, but if it makes a quick move to the downside, as a long stock holder you are definitely not - and if the move happens overnight, you might find yourself incurring a much larger loss than anticipated. Too often I've heard stories of this happening to new investors, asking themselves ''how did that happen?'' The answer is nearly always the same: they went for HUGE IMPLIED VOLATILITY!

Of course, it's important to keep in mind that any stock - no matter what the implied volatility - can get cut in half overnight. But you can play it safer by heeding the obvious dangers that high implied volatility suggest.

Regards,
Brian (OG)

In other words, a 100 dollar stock with 20% IV, and a 50 dollar stock with 25% IV and a 20 dollar stock with 30 % IV are roughly considered as medium voltility. right.

From the volatility chart Demo, I was under the impression that stocks with extremely High IV almost always goes down because of the fear factor. I believe it can also go up as well. Which direction is most likely?

Thanks you. Appreciate again your explanation.

jey