Implied volatility for stocks has ticked up over the last year opening up opportunities for investors.
Over the last year, the average volatility of stocks in the S&P 500 Index (SPX) has steadily increased. There has been pops in volatility, most notably in April this year and August 2024, but even when broad market volatility stabilizes, average stock volatility has steadily headed higher. Whatever the reason for higher individual stock volatility, 2020 seems to mark a turning point as for most of the 2010s average stock implied volatility remained below 30. Since 2020, average stock implied volatility has been around 30.
One way to take advantage of higher implied volatility on individual equities is to implement a covered call strategy at opportune times. “Opportune” is somewhat vague, but there are some general ideas like when a stock is trading at resistance or is in heavily overbought territory. Secondly, the premium of the call needs to be high enough to justify giving up some potential upside. A starting point would be that the call needs to provide at least 4% downside protection. For example, if a stock was trading at $100, then the minimum a call should be sold for is $4 with more being even better. Also, the annualized static return, the annualized return of selling the call if the stock were to trade sideways, should be above 10%. The annualized static return is an important metric because it ensures that the covered call strategy is worth the time of having the underlying position covered by the call being sold. In the watchlist tool, users can select the “Covered Call” tab to distill holdings to meet specific criteria, as shown below.
There is a great setup for a covered call strategy on Meta (META) as it’s a highly rated stock with four out of five technical attributes, trading near the top of its ten-week trading band, and has resistance nearby. Remember, a covered call strategy is a bullish strategy, so it’s important to choose stocks that are technically sound. The October 17th, $720 calls are trading just below $50 each which gives investors downside protection of 5.93% and an annualized static return of 20%. With the top of the trading band at $728 and resistance at $736, META may slow down on its recent move to the upside and the covered call strategy allows investors to bring in income while META consolidates or pulls back from these levels. While it’s by no means a guarantee that META doesn’t continue to push higher, the weight of the evidence shows that a covered call strategy is viable today.
