Criteria:
1. Strong Brand name. nn• Reputation for quality. • High repeat purchase.
2. Good Fundamentals. nn• EPS, Turnover, and Profit increasing steadily year by year. nn• Healthy Cash Flow – Cash Flow per Share greater than EPS, Cash Flow per Share greater than Capital Expenditure per Share. nn• Good management – a stable but ambitious CEO and Board. Forward-looking with an ability to embrace new technology. nn• Good financing – good Interest Cover and Dividend Cover and a Quick Ratio near to 1.
3. Healthy Debt Position. nn• Profit Margin would need to be around 10% to be able to service debt. nn• Interest Cover of 7 is good. Interest Cover of 4 is poor unless very low or negative Gearing. nn• A high ROCE would be needed to cancel out the effects of high borrowing. nn• High borrowing would need to be justified by the CEO in the annual report.
4. Consistent record of success. nn• Steadily rising EPS. nn• Increasing Dividend Yield.
5. Competitive edge. nn• Sector dominance. nn• Higher than average ROCE for the sector. nn• Good profit margins. nn• Good portfolio of patents, licences and copyrights.
6. Share price that is low for no reason.
Blue Chip Covered Calls.
1. Buy 1000 shares in a company that can be held for the longer term.
2. Buy shares whose Options will produce a minimum of 7% over 3 months, 10 over 6 months or 15% over 9 months.
Profit = Striking Price – (Share Price + Option Premium). % = Profit/Share Price*100.
3. Select shares which are moderately volatile and offer a healthy Call Premium. nn(12-mth High – 12-mth Low) /12-mth Low * 100.
4. Check the Beta for relative volatility.
5. Look for a Delta greater than 1.00 where the movement in the Call Premium exceeds the movement in the share price.
6. Do not select a Striking Price below the Cost Basis unless the Option Premium offsets the difference.
7. Try not to buy shares that have Earnings Announcements before the Strike Date. If unavoidable, watch the shares carefully.
8. Sell the Call only after the share price has appreciated somewhat.
9. Do not invest more than 20% of portfolio in one stock.
10. Check the closing prices every day.
11. Compare returns on exercising the Option versus closing and selling the Option.
12. To reduce the risk of exercise when the Stock Price is rising use the Roll Forward Technique. Buy back the Option and sell a later Call at the same Striking Price.
13. Buy the Covered Call back when the price of the share shoots up 10% or more to lock in an immediate profit.
14. Cut losses early by buying back the Call. This should be around 1 point below the break-even point (Share Price – Option Premium).
15. A Roll Down can be used to replace a Call with another that has a lower Striking Price.
16. A Roll Up can be used to replace a Call with another that has a higher Striking Price. Make sure that the loss in the original Call does not exceed the gain in the increased Striking Price.
17. Total return includes Stock Appreciation, Call Premium and Dividend Income.
18. Add in broker fees when assessing likely returns.
19. Diversify the Covered Call Portfolio with shares from different industries and sectors.
20. Complete a Covered Call Sale Criteria Sheet for every purchase and stick to the limits.