This is a guest post by Mike Scanlin of Born To Sell.

“Covered call” investing is a popular and conservative options-based income-oriented strategy. According to a recent Wall Street Journal article, 84% of Charles Schwab option-enabled accounts trade covered calls. Because of the downside protection granted from the call premium received, they are more conservative than their nearest cousin, the buy-and-hold strategy.

However, like all investment strategies it is possible to lose money with covered calls. There are ways to reduce your risk and stack the odds in your favor. A lot of it has to do with staying away from high risk situations, but there are also positive things you want to look for.

Here are the top 10 ways to improve your covered call investing:

1. Avoid leveraged ETFs. Leveraged ETFs, which are like normal ETFs except they use 2x or 3x leverage to magnify the results compared to an unleveraged ETF, are mostly day trading instruments not designed to be held over night. Not appropriate for covered calls. You can usually identify leveraged ETFs because they have words like “ultra” or “leveraged” in their names.

2. Avoid companies with earnings release dates before option expiration. Stocks are extra volatile just before and after an earnings release date. While that volatility can make for attractive call premiums, you don’t want the underlying stock to drop 20% overnight because of bad results or poor guidance.

3. Don’t count on the FDA. When there is an FDA announcement, biotech and pharmaceutical stocks tend to get cut in half or double instantly. In either scenario, covered calls are not the best strategy to take advantage of that kind of volatility. You will rarely get enough premium to cover the downside case and if you’re going to take the risk then why put a cap on your upside?

4. Avoid thinly traded stocks. Large volume makes for small spreads. The opposite is also true: thinly traded stocks and options have large spreads. These large spreads will cost you if you need to exit your position early or make an adjustment to your position. Better to stick with highly liquid stocks, or at least avoid the illiquid ones.

5. Avoid options with low open interest. Similar to #4 above, you don’t want to be in an option series that has low open interest. If you ever need to exit early you are unlikely to get a fair price in a series with low open interest. The series should have at least 2000 contracts of open interest, but as little as 1000 is probably okay.

6. Don’t chase highest return without knowing why. It’s easy to find the top yielding covered calls but those need to be viewed with a skeptical eye. Why are those options priced so high? Is there some pending news announcement? Or is the stock a momentum play? Or a short squeeze? There’s almost always a discoverable reason for juicy premiums and you want to make sure you know what it is before getting involved. Do some research.

7. Position sizing is important. Don’t put all your eggs (or even 20% of your eggs) into a single investment. If you have a small portfolio, limit each position to no more than 10% of the portfolio value; larger portfolios should target no more than 5% in a single position. If you can’t meet those goals then consider doing covered calls on diversified ETFs which have built-in diversification.

8. Dividends before option expiration are good. If the stock is going to pay a dividend then set yourself up to receive the dividend as well as the call premium. Look for ex-dividend dates before option expiration. Be aware, though, that if there is very little time premium remaining in the option on the day before the ex-dividend date then you may be subjected to early exercise.

9. Diversify. Don’t put all your covered call trades in the same industry sector. Spread them around to different sectors to avoid too much sector concentration and correlation. And, again, if your portfolio is on the smaller side then consider broad-based ETFs as they are a basket of stocks and remove much of the single-stock and single-sector risk.

10. Be prepared to own the underlying stock. Even the best laid plans sometimes don’t work out. If you’re selling short-term in the money or deep in the money options with the expectation that they will be called away, realize that they may not be called away. You may end up owning the stock after expiration. If you’re not comfortable with owning it then choose a different stock for a covered call.

Mike Scanlin is the CEO of Born To Sell, a web site dedicated to covered call investing. He has been investing in options for over 30 years. You can read more articles from Mike on his Covered Call Blog.

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10 Great Tips for Trading Covered Calls

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Tonight’s best to the point market summary comes from the WSJ,

U.S. stocks rallied as domestic home building jumped to the highest level in nearly two years and another successful Spanish debt auction buoyed investor sentiment.

The roller coaster continues… now for some updated charts.

A beautiful breakout for Automatic Data Processing (ADP) through $53. This stock looks poised to move higher from here.

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December 20th, 2011 Stock Market Analysis and ADP’s Breakout

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A very “blah” day for the markets. Nothing crazy exciting beyond Zynga (ZNGA) selling 100 million shares at $10 and starting its trading tomorrow alongside Research in Motion (RIMM) posting sour earnings (the stock is down over 7% after hours).

Thus tonight I am jumping straight to the charts. There will be no recap tomorrow as usual so I will see you back here after the weekend break. Have a good one!

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December 15th, 2011 Stock Market Recap

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(*Update 12/05/11: Special thanks to Rafal Tomal (designer of this site) for donating time out of his busy schedule to make the awesome graphic you now see on the right sidebar. Thanks for the support!)

December is one of my favorite times of year. The first snow falls (for us to the North), a lot of time is spent with family and friends, and work is put on hold in favor of delicious food and relaxation. Also, I have the opportunity to reflect back on the year with my wife and write down our next list of New Year Goals. I love setting goals .

Even with the excitement of December looming however, I spent the last few months feeling like I needed to do something more. In my heart I wanted to make some sort of difference, no matter how small, to wrap up the year. As destiny would have it I ended up stumbling across “Start Something That Matters” by Blake Mycoskie, founder of TOMS shoes. It didn’t take long for the ideas to start pooring in.

After thinking it through I had my idea.

Throughout the month of December I will donate $1 to Charity: Water for every comment, tweet, Facebook like, or Google+ made on the site. I will also donate $1 for every new fan added to the StockTradingToGo fan page.

Charity: Water is a non profit who’s mission is to provide clean water to people all over the world. To date they’ve completed over 4,000 projects serving over two million people in 25 different countries. Charity Navigator rates them a perfect 4 stars for use of funds and credibility.

My goal is to donate $500 at the end of the month. To do that though I will need your help because that is a lot of comments, tweets, likes, etc. which I cannot do on my own!

1. $1 for every comment in December – Say hi, start a discussion, ask a question, or simply share your views on the market. Every comment you leave is $1 more going towards the cause. This is a great opportunity for those of you have not yet commented before to start.
2. $1 for every StockTradingToGo Facebook fan page “like” – We have 113 fans, but with over 18,000 RSS Subscribers, I know there are more of you out there! Like STTG on Facebook and I will donate $1 in your honor.
3. $1 for every Tweet, Facebook Like, and Google+ on posts in December – Think of it as social sharing for charity. Every time you enjoy a post here on StockTradingToGo in December, share it and I will donate another $1 towards the cause.

I know that we as a community here at StockTradingToGo can make a difference this month. Charity: Water estimates that almost 1 billion people across the planet do not have access to clean drinking water. Even if we can lower that number by a few we will have made a difference.

If you have any questions or words of encouragement please feel free to leave a comment below and get this movement kick started in the right direction . Thank you in advance for your support.

(Email subscribers please visit the page to view the embedded video above.)

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Dedicating December to Supporting Charity: Water