Came across this Covered call Plan (at http://coveredwriter.blogspot.com/) by Mike Artobello, that is very detailed, with appropriate reasoning and moreover, seems realistic. I liked this writing; can be a good guidance for a covered writing portfolio.

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Covered Call Trading Plan

A covered call strategy is basically a modified version of buy and hold with a defined selling date at option expiration if the call option is ITM. For this reason, it's a long term strategy and you should only invest funds that aren't needed on a day-to-day basis or for emergencies. You should have other accounts for those purposes.

The following is an overview of my trading plan. Some specific details have been omitted, but this overview should provide the basic idea behind the plan and the methods used to implement it.

INVESTMENT PRINCIPLES

The following investment principles form the basis for this trading plan.

1. The stock market will be higher in the future than it is today.

Throughout its history, the stock market has appreciated in value, but there have been long periods of time where the market has been down or flat. However, the long term trend for the market has been up.

2. Nobody knows which stocks will go up or down.

Many professional stock analysts attempt to predict the future value of a stock. Most predictions turn out to be wrong. No amount of fundamental or technical analysis can predict, with any degree of certainty, the future value of a stock.

3. There are only a limited number of price changes that can occur.

Over a period of time a stocks price can only remain the same, go up a little, go up a lot, go down a little or go down a lot. Most investment strategies only make money when a stock goes up. An investment strategy that can make money in 4 out of the 5 possible outcomes has a better chance for success.

4. Stocks are a long term investment.

To take advantage of the long term trend in the stock market, funds need to be available for the possibility of long holding periods. If the funds are needed now or in the short term, then they should not be invested in stocks.

5. Never lose money.

Stock value will go up and down, but losses are only realized if you sell the stock for less than your cost basis. Whenever you take a loss you need to gain a greater percentage just to break even. As long as you’ve invested in good quality companies, you should hold the stock for the long term and should not sell at a loss unless absolutely necessary.

OBJECTIVE

The primary objective of this trading plan is to generate current income while preserving capital. The goal is to generate an average income of 1-2% per month or 12-24% annualized on invested capital.

Daily account balance is expected to fluctuate while there are open positions. Results will be determined by the amount of income generated (realized profit/loss) and not on the actual account balance (unrealized profit/loss).

STRATEGY

Covered calls on individual company stocks will be used to achieve the objectives. Each initial covered call position will consist of buying 100 shares of stock and selling 1 call option.

The major risk factor in trading covered calls is a sharp decline in the stock price and/or company bankruptcy. In order to minimize that risk stock selection and position sizing are critical. Companies will be selected using the principles of value investing (see Benjamin Graham's "The Intelligent Investor"). Three key elements of value investing are:

1. A thorough analysis of the company and the soundness of its underlying business, by reviewing the company’s Income Statement, Cash Flow Statement, Balance Sheet, and analysts reports, before purchasing the stock.

2. Protection against loss under all normal or reasonably likely conditions or variations. Declining positions will be held long term and managed, according to the management rules (see Position Management), until they can be closed at a profit. In order to preserve capital, no position should be closed at a loss unless absolutely necessary.

3. Setting realistic goals and not expecting extraordinary returns. As stated in the Objectives, the goal will be to generate an average annualized return of 12-24%.

TIMEFRAME

• Trading will be done in an IRA account, where the funds must remain for the next 10 years. Therefore, this is a long term account and suitable for stock investment.

• Each initial position will have an option expiration between 1-6 months out.

• Positions where the stock has declined may be held for 1 year or longer and will be managed according to the management rules (see Position Management).

POSITION SIZING

• Each initial position will consist of buying 100 shares of stock and selling 1 call option.

• Each position will be limited to between 1-5% of total capital. Only one position will be taken in any given stock. So, even if that stock would fall to zero, which is highly unlikely, it wouldn't kill the account nor wipe out all the gains.

• Dollar cost averaging will add 100 additional shares at a time up to a maximum of 5% of total capital. Exceptions will be considered on a case by case basis.

• Each month 80-90% of available capital will be invested. Cash reserves will be 10-20% of available capital. The objective is to stay as fully invested as possible and still have enough cash available to either recover existing positions or establish new ones.

• Compounding: Generated income will be re-invested, thereby compounding the returns, until such time as the income is needed (e.g. at retirement).

TRADE SELECTION

This is a high level overview of the trade selection process. I use a combination of Morningstar and PowerOptions to scan for potential trades.

Initial covered call positions should return at least 12% cash back (option premium) and a 24% annualized return if called.

Positions that meet the above requirement will be selected after reviewing the Income Statement, Cash Flow Statement, Balance Sheet, Key Ratios, Valuation Ratios, and Analyst Reports for each potential company. Companies will be selected in different sectors to diversify the portfolio.

POSITION MANAGEMENT

This is a high level overview of the position management process. For more details I recommend signing up for the free trial at Systematic Covered Writing, where they teach similiar methods for managing covered call positions.

There are only two possible outcomes for the call option at option expiration:

1. The option is exercised.
2. The option expires worthless.

At option expiration, if the stock price is higher than the option strike price, then the option is said to be in-the-money (ITM). If the stock price is lower than the option strike price, then the option is said to be out-of-the-money (OTM).

There are only five possible outcomes for the stock price at option expiration:

1. The stock price is unchanged.
2. The stock price is slightly higher.
3. The stock price is significantly higher.
4. The stock price is slightly lower, but above the strike price.
5. The stock price is significantly lower and below the strike price.

In order to meet the 12% cash back requirement on an initital position, in most cases, ITM calls will be sold. This will result in a winning trade in 4 out of the 5 possible stock outcomes.

If the option closes ITM (outcomes 1-4), then it will most likely be exercised and the stock will be called away. This is the ideal situation as it results in receiving the projected profit and a return of the invested capital.

If the option closes OTM (outcome 5), then the option will most likely expire worthless.

If the option is not exercised, then there are several possible actions that can be taken depending on the outcome of the underlying stock:

1. Sell a same strike call in a further out month.

2. Sell a lower strike call in a further out month. If the strike price is below the cost basis of the stock, you may need to buy back the call later, since you don't want the stock called away at this strike.

3. Sell a higher strike call in a further out month. You may also need to buy back the initial call before selling the higher strike call. This would be necessary to recover from #2 above.

4. Buy an additional 100 shares of stock (dollar cost averaging), and sell an additional lower strike call in a further out month. The invested capital for the entire position should not exceed 5% of total capital.

5. Close the position by either selling the stock or buying back the call and selling the stock. This should only be done at a profit. Remember, losses should be avoided, if at all possible.

That's the plan!

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