Deep In The Money Covered Calls

by Mike Scanlin

Screening for deep-in-the-money (DITM) covered calls is a little different than screening for other kinds of covered calls. For one thing, you typically have to look at longer dated expirations because there just isn't much time premium in short-term DITM options. For another thing, you probably want to stick with more seasoned names (i.e. S&P 500 stocks) rather than recent IPOs or smaller cap companies.

First Screen For DITM Covered Calls

Let's start with Born To Sell's default covered call screener settings and make three changes: (1) set the Expiration date to January 2015 to give ourselves more time, (2) set the Moneyness filter to 10% in-the-money or more, and (3) set the Minimum Open Interest filter to 300 or more (default value is 1000 but these longer dated options don't have near the same open interest as shorter-term options). Resulting screener settings look like this:

deep in the money covered call screener

The results for this first screen show lots of biotech and pharma companies. Beware! Anytime you see an Annualized Return of 110% with 40% Downside Protection (the first row with NLNK below) you have to take pause and ask "Why?"; it's too good to be true:

deep in the money screen, first pass

Second Screen For DITM Covered Calls

Biotechs and pharma companies have a tendency to make wild moves based on FDA announcements. To remove that kind of risk, let's remove all Healthcare stocks from the list. Uncheck Healthcare in the Include section of the filters:

remove healthcare stocks

Now the results look quite different. They have lower Annualized Returns, yes, but also no FDA announcement risk:

deep in the money screen, second pass

Third Screen For DITM Covered Calls

The third way to reduce risk is to limit the screener to only S&P 500 stocks. These companies are usually less volatile than their smaller company brothers. Checking the Only S&P 500 box limits screener results to only the 500 largest stocks:

limit to S&P 500 stocks

The results are now filled with symbols you are more likely to be familiar with:

deep in the money screen, third pass

Note that every company on this list has an earnings announcement prior to the January 2015 expiration date. That's normal when doing covered calls that span more than 3 months.

All of the above deep in the money covered calls have an Annualized Return of 10% or more, as well as an average Downside Protection around 15%. Not bad if you are a conservative investor. Beats bonds, and beats interest rates on idle cash. Be sure to have a diversified portfolio of these, so that if one goes south it doesn't ruin your whole plan.

Can You Lose Money With DITM Covered Calls?

Yes, of course. You can lose money with any investment. Since these offer 15% Downside Protection the first 15% of any drop is covered by the combination of in-the-moneyness (i.e. intrinsic value) and time premium.

As always, these are not recommendations. They are just candidates to begin your search for a DITM covered call that meets your particular investment requirements. Do your own homework before investing. You may also enjoy our earlier article and video on Deep In The Money Calls.

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.