If you own stocks and want to earn extra income from them, the covered call strategy might be exactly what you're looking for. It's one of the most popular and beginner-friendly options strategies used by investors worldwide. In this guide, we'll break down how covered calls work, when to use them, and how to evaluate whether they're right for your portfolio.
What Is a Covered Call?
A covered call is an options strategy where you sell (write) a call option against shares of stock that you already own. The word "covered" means your obligation to deliver shares is backed by the stock in your account — you're not exposed to unlimited risk like a naked call seller would be.
Each standard options contract represents 100 shares of the underlying stock. So to sell one covered call, you need to own at least 100 shares of the stock.
How Does It Work?
Here's the step-by-step process:
Step 1: You own 100 shares of a stock (for example, XYZ trading at $50 per share).
Step 2: You sell a call option with a strike price above the current price (e.g., a $55 strike expiring in 30 days).
Step 3: You collect the option premium immediately (e.g., $1.50 per share = $150 per contract).
What Happens at Expiration?
There are two possible outcomes:
Why Use Covered Calls?
Covered calls are popular for several reasons:
Generate income: Collect premium payments regularly, similar to dividends. Many investors sell weekly or monthly covered calls to create a steady income stream.
Reduce cost basis: Every premium collected lowers your effective purchase price for the stock, providing a cushion against small declines.
Lower risk than buying options: Unlike buying calls or puts where you can lose your entire investment, covered calls involve owning the underlying stock with an income overlay.
Works in flat markets: Even if a stock goes sideways, you still earn the premium. This makes covered calls especially attractive in low-volatility or range-bound markets.
Key Terms to Know
Strike Price: The price at which your shares will be sold if the option is exercised. Higher strikes give you more upside but pay less premium.
Premium: The cash you receive for selling the call option. This is yours to keep regardless of what happens.
Expiration Date: When the option contract expires. Shorter expirations (weekly/monthly) tend to have faster time decay, which benefits the seller.
In-the-Money (ITM): When the stock price is above the strike price. ITM covered calls pay higher premiums but have a higher chance of assignment.
Out-of-the-Money (OTM): When the stock price is below the strike price. OTM covered calls give you more room for the stock to appreciate before being called away.
What Are the Risks?
Capped upside: If the stock surges well past your strike price, you miss out on those gains. Your shares get sold at the strike price.
Stock decline: The premium provides a small buffer, but if the stock drops significantly, the premium won't fully offset the loss.
Opportunity cost: While your covered call is active, your shares are effectively committed. You may not want to sell them even if market conditions change.
A Real-World Example
Let's say you own 200 shares of AAPL at $190 per share.
You sell 2 call contracts (200 shares) with a $200 strike expiring in 30 days for $3.00 per share.
Premium collected: $3.00 x 200 shares = $600
If AAPL stays under $200: You keep the $600 and your shares. Annualized, that's roughly a 19% return just from premium.
If AAPL rises to $210: Shares are called away at $200. You profit $10/share ($2,000) + $600 premium = $2,600 total. You miss the extra $10/share above $200, but you still profit handsomely.
How Covered Call Scan Helps
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Whether you already own shares or are looking to buy stock specifically for covered calls, the scanner helps you make informed decisions with real-time market data.