In this text we cover how to sell a covered call and where.
Selling a covered call lets you earn extra income from stocks you already own while potentially profiting if the stock price rises.
This strategy works by selling someone else the right to buy your shares at a specific price before a certain date.
You sell a covered call by owning 100 shares of a stock, choosing a strike price and expiration date, then placing a sell-to-open order for a call option through your broker.
What happens “in the background” is that the buyer pays you a premium upfront for this right.
If the stock stays below your chosen strike price, you keep both the premium and your shares.
This approach can boost your returns in flat or slowly rising markets. You keep the premium no matter what happens, but you might have to sell your shares if the stock price goes above your strike price before expiration.
Foundations of Selling Covered Calls
Covered calls combine stock ownership with options trading to create income from your existing shares. This strategy involves specific terms, mechanics, and trade-offs that every investor should understand before starting.
Understanding Covered Calls
A covered call is an options strategy where you own 100 shares of stock and sell a call option on those same shares. You become the option writer when you sell the call contract.
The buyer of your call option pays you a premium upfront. This premium becomes your immediate income regardless of what happens to the stock price.
Your shares “cover” the call option you sold. If the buyer exercises their right to buy your stock, you already own the shares to deliver.
This strategy works best with stocks you already own or plan to buy. You keep collecting dividends on your shares while earning extra income from the option premium.
Key Terms and Concepts
Premium is the money you receive for selling the call option. This amount depends on the stock price, strike price, and time until expiration.
Strike price is the price at which the buyer can purchase your shares. You choose this price when selling the call.
Expiration date is when the option contract ends. Most investors use monthly expiration dates.
Assignment happens when the option buyer decides to purchase your shares at the strike price. You must sell your 100 shares at the agreed price.
Underlying stock refers to the shares you own that back up the call option contract.
How Covered Calls Work
You start by owning 100 shares of stock for each call option you want to sell. One option contract always covers exactly 100 shares.
You sell a call option with a strike price above the current stock price. The buyer pays you a premium that goes into your account immediately.
If the stock stays below the strike price, the option expires worthless. You keep the premium and still own your shares.
If the stock rises above the strike price, the buyer may exercise the option. You sell your shares at the strike price and keep the premium.
Your profit comes from three sources: the option premium, any dividends, and potential stock appreciation up to the strike price.
Benefits and Risks
Covered calls generate immediate income through option premiums. This extra money can improve your overall investment returns.
The strategy provides some downside protection. The premium you collect reduces your cost basis in the stock.
You limit your upside potential when the stock price rises above the strike price. Your shares get called away at the strike price.
Market risk still exists because you own the underlying stock. If shares fall significantly, the option premium may not offset your losses.
You face opportunity cost if the stock rises well above your strike price. Missing out on large gains is the main trade-off of this strategy.
How to Sell a Covered Call Step by Step
Selling covered calls requires owning 100 shares of stock for each contract and choosing the right strike price and expiration date. You’ll need a brokerage account with options trading approval and must manage the position until expiration or assignment.
Selecting the Right Stock and Options
Choose stocks you already own or plan to buy in 100-share blocks. The best stocks for covered calls have steady prices with moderate volatility.
Look for stocks that pay dividends. You keep these payments even if your shares get called away. ETFs work well too since they often have lower volatility than individual stocks.
Pick stocks trading between $20 and $200 per share. Lower-priced stocks may not have enough premium to make the strategy worthwhile. Higher-priced stocks require more cash to buy 100 shares.
Check the options chain for good premium levels. You want at least $0.50 per share in call premium. This equals $50 per contract since each contract covers 100 shares.
Avoid stocks with upcoming earnings or major news events. These can cause big price swings that hurt your position.
Opening and Managing Your Brokerage Account
You need options trading approval from your brokerage. Most brokers offer different approval levels. Covered calls usually need Level 1 or Level 2 approval.
The application asks about your trading experience and financial situation. Be honest about your knowledge level. Some brokers approve covered calls for beginners since they’re considered safer than other options strategies.
You can sell covered calls in cash accounts or margin accounts. Cash accounts require you to own the shares outright. Margin accounts let you borrow money to buy shares, but this adds risk.
Keep enough cash in your account for commissions and fees. Most brokers charge $0.50 to $1.00 per options contract. Some offer commission-free stock trades but still charge for options.
Set up your account to show options chains and Greeks. These help you pick the right strike price and expiration date.
Choosing Strike Price and Expiration
Pick a strike price above your stock’s current price. This is called an out-of-the-money call. You’ll collect less premium but keep any stock gains up to the strike price.
At-the-money calls offer more premium but higher assignment risk. In-the-money calls give the most premium but almost guarantee assignment.
For expiration dates, start with 30 to 45 days out. This balances premium collection with time decay. Shorter expirations decay faster but offer less premium.
Monthly options expire on the third Friday of each month. Weekly options give you more choices but may have lower trading volume.
Compare premium amounts across different strikes and dates. Higher volatility stocks offer more premium but carry more risk of big price moves.
Check the bid-ask spread before trading. Wide spreads make it harder to get fair prices when entering or exiting positions.
Placing the Covered Call Trade
Enter a “sell to open” order for call options. Make sure you select the right expiration date and strike price. Double-check the number of contracts matches your share count.
Use limit orders instead of market orders. Set your limit price at or near the bid price. This helps ensure you get a fair price for your premium.
The premium goes into your account immediately when the trade executes. This cash is yours to keep regardless of what happens to the stock price.
Monitor your order during market hours. Options can have wide bid-ask spreads, especially for less active stocks. You may need to adjust your limit price.
Keep records of your trade details. Note the premium received, strike price, and expiration date. You’ll need this information for tax purposes and position management.
Managing the Covered Call Position
Watch your stock price as expiration approaches. If it stays below the strike price, the option expires worthless. You keep the premium and still own your shares.
If the stock price rises above the strike price, assignment becomes likely. The option buyer may exercise their right to buy your shares at the strike price.
You can buy back the call option before expiration. This closes your position early but costs money. Do this if you want to keep your shares or avoid assignment.
Assignment can happen any time before expiration, but it’s most common near the expiration date. You’ll receive cash equal to the strike price times 100 shares per contract.
Track dividends if your stock pays them. You only receive dividend payments if you own the shares on the ex-dividend date.
Potential Outcomes and Adjustments
Three main outcomes can occur at expiration. The option expires worthless, you get assigned, or you buy back the call early.
When options expire worthless, you keep the premium and your shares. This happens when the stock price stays below the strike price. You can then sell another covered call for additional income.
Assignment means selling your shares at the strike price. Your total gain includes the call premium plus any stock appreciation up to the strike price. You’ll owe taxes on these gains.
Rolling the position forward involves buying back the current call and selling a new one with a later expiration date. This costs money but lets you keep your shares longer.
If the stock drops significantly, you might face losses on your shares that exceed the premium received. The covered call provides limited downside protection equal to the premium amount.
