Covered Call Writing – Fundamental and Technical Analysis: Earnings and Price Strength Analysis

Successful covered call writing requires discipline and appropriate analysis specific for this great strategy. In the Blue Collar Investor (BCI) methodology we incorporate three major screening components before we even look at options chains:

• Fundamental analysis
• Technical analysis
• Common sense principles

The details of the entire screening process are discussed in my books and DVDs and in today’s article we are going to focus in on one critical aspect of the fundamental component and one from the technical component. The fundamental screens used in the BCI methodology include two from Investor’s Business Daily and one from Money Central’s Scouter Screen. These are the first screens we run our securities through and then move on to the other technical and common sense screens. One of the most important statistics as they relate to fundamental analysis is related to earnings growth. Companies that show strong stats in this areas will become “darlings” for the institutional investors, the folks who move the market. The most pertinent screen in this regard in the IBD Smart Select Ratings screen (predominantly fundamental in nature with a technical component). Two of the parameters measured in this screen are EPS rating and RS Rating, the latter a technical screen.

EPS Rating: This compares a company’s earnings per share growth on both a current and annual basis with all other publicly traded companies in the IBD database. In the BCI methodology we require all of our eligible covered call writing candidates to be in the top 20% of all considered securities. This ensures that our choices have both short-term and long-term strength as it relates to earnings growth.

RS Rating: This screen measures a stock’s price performance over the past 12 months compared to all other equities in the database. Here again, we require all of our “eligible” stocks to be in the top 20%.

Now this brings me to an interesting chart which was published in a recent issue of  Investor’s Business Daily. It is called the IBD Weekly Review 85-85 Index. The two key requirements for a stock to be included in this index are Earnings Per Share and Relative Price Strength Ratings of 85 or higher, nearly mirroring the requirements of the BCI methodology. Here is a screen shot of that chart:

Earnings and Price Strength Analysis

Although this index does not precisely mirror that of the BCI methodology, it comes quite close and the results over the 12-year period is quite impressive. The point to consider is that using BOTH fundamental and technical analysis will enhance our opportunity for achieving maximum profits when writing calls on these equities. In our BCI screens we use so much more than the two I am highlighting in today’s article. It is important to achieve a balance between maximizing our opportunities to achieve the highest possible returns and analysis paralysis. In our BCI methodology we use very specific screens with consistent technical analysis parameters and then add in our extremely important common sense parameters (avoiding earnings reports and much more).

For our new members the process may seem a bit complicated at first but like learning how to use a computer after a while it becomes second nature as well as user and time friendly. Our BCI team does the ENTIRE screening process for our premium members but this is certainly something you can do yourself if time is not an issue and if you are so inclined. The important takeaway from this article is that the screening process MUST include all three screening components before investigating an options chain:

• Fundamental analysis
• Technical analysis
• Common sense principles

If we only consider securities that meet all of our strict BCI requirements as “eligible” for covered call writing candidates our opportunity to achieve maximum returns will be enhanced exponentially.

Florida seminar:

Thanks to all BCI members who attended my recent presentation in Coral Springs Florida. Besides escaping from the brutal NY weather, it was a pleasure getting to meet you in person. My next seminar will be in Atlanta in April.

Market tone:

The Federal Reserve officials appeared relatively optimistic this past week as it stated that “moderate economic growth” has returned. This was backed by the week’s economic reports:

• The Fed will keep its target rate for short-term interest rates between 0% and 0.25% as long as unemployment remained above 6.5% and inflation below 2.5%.
• The Fed will continue to buy $40 billion worth of agency mortgage-backed securities and $45 billion worth of US Treasuries per month. This will keep long-term interest rates low and borrowing more affordable
• New home construction was strong in February with 917,000 new homes started, 0.8% higher than the upwardly revised January statistic and above expectations
• The rate of new residential construction is up 27.7% from a year ago
• Existing home sales rose 0.8% in February, 10.2% higher than February, 2012. This was the 20th straight month that sales exceeded the year-ago level
• The Conference Board index of leading economic indicators rose 0.5% in February, above expectations and January results were revised upward. This index has gone up in three straight months and five of the past six. It is important to consider that these stats do not take into consideration the impact that sequestration (budget cuts to federal spending that started on March 1st) may have and that is why my outlook may appear a bit muted despite the favorable reports
• Initial jobless claims for the week ending March 16th came in at 336,000, less than the 345,000 anticipated

For the week, the S&P 500 declined by 0.2% for a year-to-date return of 10%, including dividends.

Summary:

IBD: Confirmed uptrend

BCI: Moderately bullish but still favoring in-the-money strikes until the impact of sequestration can be measured

Wishing you the best in investing,

Alan

[email protected]

www.thebluecollarinvestor.com