Alpha Score
The Alpha Score is a composite metric (0–100) that identifies the best covered call opportunities by combining three signals: effective yield (premium you'd actually capture after spreads), bullish sentiment (negative skew), and bullish positioning (high call/put volume ratio).
Effective Yield = Annualized Yield × BS Efficiency
Alpha Score = 0.40 × Norm(Eff. Yield) + 0.30 × Norm(Skew) + 0.30 × Norm(C/P)
BS Efficiency is folded directly into yield rather than ranked separately. This means a stock with 3% yield but 0.55 BS Efficiency (effective yield = 1.65%) will score lower than a stock with 2% yield but 0.95 BS Efficiency (effective yield = 1.90%).
Each component is min-max normalized to 0–100 within the current dataset:
Norm(x) = (x − min) / (max − min) × 100
Unlike percentile ranking, min-max normalization preserves the magnitude of differences. If one stock has 50% effective yield and another has 10%, the 5x gap is reflected in the score — not compressed into adjacent ranks.
Outlier clipping: Before normalizing, values are clipped at the 5th and 95th percentile. This prevents a single extreme outlier (e.g., a stock with 500% annualized yield due to bad data) from compressing all other stocks to near zero.
- Eff. Yield (40%): Normalized effective yield (annualized yield × BS efficiency). Higher = 100.
- Skew (30%): Normalized put/call skew (inverted: most negative = 100, most bullish).
- C/P (30%): Normalized call/put volume ratio. Higher = 100.
Example
Among 50 stocks, effective yields range from 5% to 40% (after clipping):
Stock A: Eff. Yield = 24.8% → Norm = (24.8 − 5) / (40 − 5) × 100 = 56.6
Stock B: Eff. Yield = 27.6% → Norm = (27.6 − 5) / (40 − 5) × 100 = 64.6
Stock C: Eff. Yield = 38.0% → Norm = (38.0 − 5) / (40 − 5) × 100 = 94.3
Notice how Stock C scores much higher than B, reflecting the actual magnitude gap. With percentile ranking, C and B might only differ by a few points despite the 10% yield difference.
Premium Yield
The percentage return you would earn by selling one covered call against your stock position, using the nearest at-the-money (ATM) call option.
Premium Yield = Call Premium / Current Stock Price
where Call Premium = (Bid + Ask) / 2 of the nearest ATM call
Example
AAPL is trading at $250. The nearest ATM call (strike $250, expiring in 30 days) has a bid of $5.20 and ask of $5.60.
Mid-price = ($5.20 + $5.60) / 2 = $5.40
Premium Yield = $5.40 / $250.00 = 2.16%
This means you'd earn 2.16% on your capital by selling this call, over the 30-day period.
Annualized Yield
The premium yield extrapolated to a full year, allowing comparison across options with different expiration dates.
Annualized Yield = Premium Yield × (365 / DTE)
where DTE = Days to Expiration
Example
Continuing the AAPL example above (2.16% yield, 30 DTE):
Annualized Yield = 2.16% × (365 / 30) = 26.28%
Compare this to a stock offering 3% yield over 90 days: 3% × (365/90) = 12.2%. Despite the higher raw premium, the annualized return is lower — the AAPL trade is more capital-efficient.
Implied Volatility (IV)
The market's expectation of future price movement, derived from option prices. Higher IV means the market expects bigger moves, which translates to higher premiums.
IV = Volume-Weighted Average of ATM Option Implied Volatilities
ATM = contracts with strikes within 5% of current price
Weight = contract volume / total ATM volume
We use volume-weighted averaging because:
- Liquid contracts better represent true market consensus
- Illiquid strikes can have stale or distorted IV values
- Both calls and puts near ATM are included for robustness
Put/Call Skew
Measures the difference in implied volatility between ATM puts and ATM calls. This reveals whether the market is pricing in more fear (downside) or greed (upside).
Skew = Avg ATM Put IV − Avg ATM Call IV
Negative skew (e.g., −3.2%): Calls are more expensive than puts. The market expects upside. Bullish signal.
Positive skew (e.g., +5.1%): Puts are more expensive than calls. The market is buying downside protection. Bearish/fear signal.
Example
NVDA at $800. ATM calls (strikes $790–$810) have average IV of 45%. ATM puts (same strikes) have average IV of 42%.
Skew = 42% − 45% = −3.0%
Negative skew means traders are paying more for upside calls than downside puts — they expect NVDA to rally. As a covered call seller, this is ideal: the high premium is driven by bullish demand, not crash fear.
Call/Put Volume Ratio (C/P)
The ratio of total call volume to total put volume across all strikes. Measures directional positioning by options traders.
C/P Ratio = Total Call Volume / Total Put Volume
C/P > 1.0: More calls trading than puts — bullish positioning.
C/P ≈ 1.0: Balanced — neutral sentiment.
C/P < 1.0: More puts trading than calls — bearish/hedging activity.
Example
META has 150,000 calls traded and 80,000 puts traded today.
C/P Ratio = 150,000 / 80,000 = 1.88
A ratio of 1.88 means nearly twice as many calls are trading as puts. Traders are actively betting on upside, making this a favorable environment for selling covered calls.
BS Efficiency
Measures how much of an option's value you actually capture when selling, based on the bid-ask spread. Since you sell at the bid price (not the mid), tighter spreads mean higher efficiency. This is the most critical factor in whether a covered call strategy actually works in practice.
BS Efficiency = Bid Price / Mid-Price
where Mid-Price = (Bid + Ask) / 2
The ratio is always between 0 and 1. It directly measures the percentage of the option's fair value you'd receive when selling:
BS Eff. ≥ 0.95: Excellent — very tight spreads. You lose less than 5% to the spread. Typical of mega-cap stocks (AAPL, MSFT, TSLA).
0.90 ≤ BS Eff. < 0.95: Good — moderate spreads. Most large-cap S&P 500 stocks.
0.80 ≤ BS Eff. < 0.90: Fair — noticeable spread cost. Consider whether the yield justifies it.
BS Eff. < 0.80: Poor — you're losing 20%+ of the option's value to the spread. Avoid for covered calls.
Example
AAPL ATM call: Bid = $4.90, Ask = $5.10
Mid = ($4.90 + $5.10) / 2 = $5.00
BS Efficiency = $4.90 / $5.00 = 0.98
You capture 98% of the fair value — only 2% lost to the spread.
Compare with a small-cap biotech: Bid = $1.50, Ask = $2.50
Mid = ($1.50 + $2.50) / 2 = $2.00
BS Efficiency = $1.50 / $2.00 = 0.75
You lose 25% of the value to the spread — the “high premium” is a mirage.
How it's used in Alpha Score
BS Efficiency is multiplied into the annualized yield to produce Effective Yield (what you'd actually earn). This effective yield is then percentile-ranked for the Alpha Score, so illiquid options are naturally penalized without needing a separate rank.
Stock A: 3.0% yield × 0.75 efficiency = 2.25% effective
Stock B: 2.0% yield × 0.98 efficiency = 1.96% effective
Backtesting note
Historical options bid/ask data is not freely available, so the backtest uses a liquidity proxy based on trailing stock price levels (higher-priced, more liquid stocks tend to have tighter option spreads). When using the “Alpha + BS Efficiency” selection method, each stock gets a per-trade capture rate instead of a flat global discount. This avoids data leakage — only prior-day data is used.
Weekly Realized Volatility
The actual historical volatility of the stock over each calendar week, calculated from daily returns. Comparing this to current IV helps identify whether options are overpriced or underpriced.
Daily Return = ln(Closet / Closet-1)
Weekly Vol = StdDev(Daily Returns) × √252
IV > Realized Vol: Options are priced “rich” — good for sellers. You're collecting more premium than the stock's actual movement justifies.
IV < Realized Vol: Options are priced “cheap” — the stock is moving more than the market expects. Higher risk for covered call sellers.
Example
TSLA has current IV of 55% but last week's realized vol was only 35%.
IV is 20 percentage points higher than realized vol — options are priced rich. As a covered call seller, you're collecting premium based on 55% expected movement while the stock is only actually moving at 35%. This is an ideal setup.
Putting It All Together
The ideal covered call candidate has:
High Annualized Yield — You earn meaningful income relative to capital deployed.
Negative Skew — The high premium is driven by bullish call demand, not crash fear.
High C/P Ratio — Options traders are positioned for upside, confirming bullish sentiment.
High BS Efficiency — The options are liquid with tight spreads, so you actually capture the premium you see on screen.
IV > Realized Vol — You're selling overpriced options, giving you an edge over time.
The Alpha Score captures criteria 1–4 in a single number. It finds stocks where high premiums are backed by bullish sentiment AND liquid options — so the yield you see is the yield you get.
Rolling at Profit
Instead of holding a covered call to expiration, you can close the position early when the option has lost a target percentage of its value, then immediately open a new position. This is called “rolling.”
Roll trigger: Current Option Value ≤ Initial Premium × (1 − Roll%)
At 50% profit: close when option is worth ≤ 50% of what you sold it for
How it works in practice
Day 1 (Monday): Buy AAPL at $250, sell 30-DTE ATM call for $5.00 premium.
Day 10: AAPL is at $251. The call has decayed from $5.00 to $2.40 (less than 50% of original). Roll triggered.
Close: Buy back the call for $2.40. Net premium captured: $5.00 − $2.40 = $2.60. Sell AAPL at $251.
P&L: Stock gain ($1.00) + net premium ($2.60) = $3.60 per share.
Re-enter: Pick the best stock again, buy shares, sell a new call. Capital is redeployed 20 days earlier than waiting for expiration.
Why roll at 50% profit?
- Theta decay is front-loaded: Options lose the first 50% of their time value faster than the last 50%. You capture the “easy” half of the premium quickly, then redeploy.
- Reduces gamma risk: As expiration approaches, gamma increases sharply. Closing early avoids the period where small stock moves cause large P&L swings.
- Capital efficiency: Instead of waiting 30 days for the remaining $2.50 of time value to decay (which may not happen if the stock moves), you redeploy your full capital into a fresh position.
- Research-backed: tastytrade's analysis of millions of trades found that managing winners at 50% of max profit produced better risk-adjusted returns than holding to expiration.
Backtesting implementation
When rolling is enabled, the backtest checks each trading day between entry and expiration. It estimates the current option value using Black-Scholes with the remaining time and original volatility. If the option has decayed past the roll threshold, the position is closed: the option is bought back at its current estimated value (discounted by the same capture rate), and the stock is sold at the closing price. A new trade is entered at the next available Monday.
Validating Your Backtest
Since our backtest uses Black-Scholes simulated premiums (not real market prices), it's important to verify the results are realistic. The BXM index (CBOE S&P 500 BuyWrite Index) serves as the ground truth.
How to validate
- Go to the Backtest page.
- Set Stock Selection to “SPY Only (BXM benchmark match)”.
- Set DTE to 30 days and Strike to ATM.
- Set Roll at Profit to Disabled (BXM holds to expiry).
- Run the backtest. Your strategy line (green) should closely track the dashed violet BXM line.
Lines overlap closely: The simulation is accurate for this configuration. You can trust the results when you change stock selection methods.
Strategy above BXM by 2-5%/yr: Moderate divergence. The BS approximation is slightly overstating premiums. Results are directionally correct but optimistic.
Strategy above BXM by >5%/yr: Significant overestimation. Adjust the Premium Capture Rate slider down until the lines match, then use that calibrated rate for your other backtests.
Calibrated parameters (validated against BXM):
IV Premium Multiplier = 1.25 (realized vol × 1.25 ≈ implied vol)
Premium Capture Rate = 87% (after bid-ask spread and slippage)