What is a covered call?
– A covered call is an options strategy where you sell (write) a call option while owning the underlying shares. Because you already hold the shares, you can deliver them if the buyer exercises the option. Selling the call generates immediate income (the option premium) while you keep the stock position.
Key terms (brief definitions)
– Call option: a contract that gives the buyer the right, but not the obligation, to buy the underlying asset at a specified price (the strike) before or at expiration.
– Premium: the cash you receive when you sell the option; quoted on a per-share basis.
– Strike price: the agreed price at which the option buyer can buy the stock.
– Assignment: when the option buyer exercises and the option seller must fulfill the contract (deliver 100 shares per contract).
Why traders use covered calls
– Income generation: collect premiums while holding the stock.
– Short-term hedge: premiums provide a small buffer against modest declines.
– Neutral-to-slightly-bullish view: useful when you expect little upside in the near term but want to keep the shares.
Basic math: maximum profit and maximum loss
– Maximum profit per share = (Strike − Purchase price) + Premium received.
– Explanation: If the call is exercised, you sell the shares at the strike, capturing price appreciation up to the strike plus the premium.
– Maximum loss per share = Purchase price − Premium received.
– Explanation: In the worst case the stock falls to zero; your net loss is the amount you paid for the stock minus the premium you kept.
– Breakeven price at purchase = Purchase price − Premium received.
Worked numeric example (one contract = 100 shares)
– You buy 100 shares at $90.00 (cost = $9,000).
– You sell one call with strike $100, receive a $1.00 premium per share (premium = $100).
– If the stock rises above $100 and the call is exercised:
– You sell 100 shares at $100 = $10,000.
– Profit = ($10,000 − $9,000) + $100 premium = $1,100 total, or $11 per share.
– If the stock falls to $0:
– Loss = $9,000 − $100 = $8,900 total, or $89 per share.
– Breakeven = $90 − $1 = $89 per share.
Practical steps to implement (simple checklist)
1. Confirm account permissions: ensure your brokerage allows options writing and you understand any margin/cash requirements.
2. Own at least 100 shares of the underlying (or buy them first).
3. Select strike and expiration consistent with your objective (income vs. willingness to have shares called away).
4. Sell the call and collect the premium.
5. Monitor the position as expiration approaches:
– If stock stays below strike, option likely expires worthless —
— you keep the premium and continue to own the shares.
– If the stock rises above the strike, the call is likely to be exercised (assigned) — your 100 shares will be sold at the strike price; your total realized proceeds = strike × 100 + premium received. Using the earlier numbers: bought at $90, sold (assigned) at $100, plus $1 premium → profit = (100 − 90) × 100 + 100 = $1,100 total, or $11 per share.
– If the option is in-the-money before expiration there is also a risk of early assignment (the buyer exercising early). Early assignment is more likely when the option is deep in-the-money and the underlying is about to pay a dividend (the buyer captures the dividend). If you want to avoid early assignment risk, consider closing the short call before an ex-dividend date.
Managing and adjusting positions (practical actions)
1. Let it expire worthless: do nothing; you keep the premium and retain shares. Best when you want ongoing income and don’t mind holding the stock.
2. Buy to close: buy the same call you sold to remove the obligation. Use this when you want to preserve upside or limit assignment risk.
– Example: sold call for $1; underlying rallies and the call now trades for $5. Buying to close costs $5, so net loss on the option = $4 per share, which reduces your overall position return.
3. Roll the call: buy to close the near-term call and simultaneously sell another call with a later expiration and/or different strike (sell-to-open). Rolling can:
– Extend income collection (time value),
– Move the strike up to allow more upside,
– Or move the strike down to collect more premium (but increases assignment risk).
– Example: sold 100-strike expiring Friday for $1. Friday arrival: instead of assignment, buy to close for $2 and sell the 105-strike expiring next month for $3 → net credit = +$0 (but you changed strike & time).
4. Accept assignment: if assigned, you will sell your shares at the strike; you can then decide whether to re-buy the shares in the market (possibly at a higher price) or deploy capital elsewhere.
5. Convert to a synthetic covered call / protective combination only if you fully understand options spreads and margin implications.
Key risks and considerations (checklist)
– Upside cap: covered call caps your upside at the strike; large stock rallies mean opportunity cost.
– Downside exposure: premium provides only limited downside protection equal to the amount received.
– Early assignment: more likely around dividends or with deep in-the-money short calls.
– Transaction costs and liquidity: commissions, wide bid-ask spreads, and low option liquidity increase execution costs.
– Tax consequences: premiums and assignment have tax effects — see below.
– Margin and account permissions: ensure your brokerage allows writing covered calls and check whether you need a margin or cash account.
Taxes (brief, general guidance — consult a tax professional)
– Premium received is generally taxable when the option is closed, expires, or is exercised. If the option expires, the premium is usually short-term capital gain.
– If the short call is exercised, assignment becomes a sale of the underlying at the strike; the premium adjusts your sale proceeds or cost basis depending on the timing and your prior holding period.
– Specific tax treatment depends on jurisdiction and circumstances (holding period, wash sale rules, etc.). Refer to official tax guidance.
Quick decision checklist before entering a covered call
– Do I have (or will I buy) at least 100 shares?
– Is my objective income (collect premium) or a willingness to be called away?
– What strike gives the right balance between income and upside I’m willing to forgo?
– How far out should expiration be (time value vs. frequency of premium)?
– Are there upcoming earnings, dividends, or corporate actions?
– Is the option liquid (reasonable volume and tight spreads)?
– Do I understand the tax and early-assignment implications?
Simple worked example (recap)
– Buy 100 shares at $90 → cost $9,000.
– Sell 1 call (100-strike) for $1.00 → receive $100 premium.
– Outcomes at expiration:
– Stock ≤ $100 → option expires worthless; you keep $100; effective cost basis = $89/share.
– Stock > $100 → assigned at $100; realized sale proceeds = $10,000 + $100 premium = $10,100; profit = $1,100.
Sources for further reading
– Cboe — Covered Call Overview: https://www.cboe.com/learncenter/covered-call
– Options Clearing Corporation — Options Basics: https://www.theocc.com/what-we-do/options-basics
– U.S. Securities and Exchange Commission (Investor.gov) — Options Strategies: https://www.investor.gov/introduction-investing/investing-basics/investment-products/options
– Investopedia — Covered Call Definition: https://www.investopedia.com/terms/c/coveredcall.asp
– IRS Publication 550 — Investment Income and Expenses (tax rules for options): https://www.irs.gov/publications/p550
Educational disclaimer
This material is educational only and not individualized investment advice. Covered-call strategies involve multiple risks: you can lose principal if the underlying stock falls; you may have to sell (be assigned) shares before expiration if the buyer exercises the call; and there are transaction costs, margin requirements, and potential tax consequences (exercise, assignment, and wash-sale rules can affect timing and taxable gains). Before implementing any options strategy, verify commission and margin rules with your brokerage, consider potential tax outcomes with a qualified tax advisor, and consult a licensed investment professional about whether the strategy fits your objectives, time horizon, and risk tolerance.
Selected reputable resources for further study
– FINRA — Options: https://www.finra.org/investors/options
– Options Industry Council (OIC) — Options Education: https://www.optionseducation.org/
– U.S. Securities and Exchange Commission — Options and Investors: https://www.sec.gov/investor/pubs/options.htm
– IRS — Publication 550, Investment Income and Expenses: https://www.irs.gov/publications/p550
If you want a short checklist to use before writing (selling) a covered call, ask and I’ll provide one tailored to beginners or to more advanced traders.