The decision for the trader is - is the premium collected worth the risk profile assumed?
this is the guts of the whole thing, and wayne also correctly states somewhere else that the premium has to be compared to the probability of various outcomes, or in other words the anticipated distribution of share price returns over the time till expiry, to determine whether writing this call at this time for this premium has a positive expected value, or a higher expected value than whatever the alternative is (presumably continue to hold the stock).
here is a chart of a very crude method of comparing the cc strategy to a buy and hold strategy; the share is NAB and the period is feb 2003 to may 2010
the thick blue line represents the difference in returns ie the improvement or other wise between always being short a call over 100% of the stock v a simple buy and hold stategy
the calls measured are all 20 trading day duration and in this chart i have assumed a constant 3% premium is obtained, which is equivalent to an IV of 26%
all good eh in this case since buy and hold has produced a negative return, writing calls has improved the return considerably.
now this is the same chart but i have changed the premium recieved each time to 2% which equates to an IV=16.5%;
different story now we are only getting 2%, which appears to be around the equilibrium point where the two strategies are roughly equal
now I of course know that the premium is never a constant and indeed it fluctuates a lot (i did say it was a crude analysis) but the point is that IT DEPENDS HOW MUCH YOU GET for assuming that obligation.
That is to say, you should not just decide that writing calls is a great strategy and just blindly write call after call without considering the level of premiums available v the distribution of possible outcomes. Or in other words comparing IV to expected volatility. Or to shorten it some more; sell premium when IV is higher than expected volatility.
now here is another one with completely diffrent price behaviour. This time the stock is BHP which has roughly quadrupled in price over the same time. in BHP writing calls at 26% IV would have resulted in severely curtailing the capital growth that buy and hold enjoyed.
now i change the premiums recd to an unlikely 5% and this chart shows that IF YOU GET ENOUGH premium writing calls can have a + EV even on a rising stock.
Personally i am a fan of writing calls on blue chip stocks that i hold and am happy to hold for the long term, but always subject to the IV available and the stocks position its own range. It doesnt get mentioned often but another variable you can influence is you can vary the ratio between stocks held and options written. depending on circumstances i may write calls on between 50% and 200% of stock held, which has a big influence on the payoff profiles
I am also a fan of writing puts as an accumulation and trading strategy, if circumstances are appropriate, and if i can get them on the same stock as we are short a call on at different points in its trading range so much the better.
One thing i wouldnt ever do is buy stock and write a call at the same time ie buy/write. If i wanted to assume that payoff profile i would instead write a naked put - same payoff, less capital tied up.
also agree with wayne that stocks with a high IV generally have a good chance of a big move either way, and these are the least appropriate for doing a buy/write on due to the unfavourable risk:reward ratio (ie small win or big loss). For me, i stick to blue chips for this stategy