Covered Call

A covered call combines owning shares with selling a call option on those shares. You collect the call premium as income. In exchange, you agree to sell your shares at the strike price if the call is exercised, which caps your upside. Covered calls are among the most widely used option strategies, popular with long term investors who want extra income from holdings they expect to rise slowly or move sideways.

How it works#

1. Own 100 shares (one contract's worth) of a stock or ETF.
2. Sell one call, usually out of the money, expiring in 30 to 45 days.
3. Collect the premium.
4. At expiry: if the stock is below the strike, the call expires and you keep shares and premium. If above, your shares are sold at the strike (you can also buy the call back or roll it before then).

Payoff at a glance#

Worked example#

The trade off#

Covered calls turn uncertain future upside into certain income today. They:

• Add return in flat or slowly rising markets.
• Cushion small declines by the amount of the premium.
• Give up large gains above the strike.
• Do not protect against big declines, beyond the premium.

Research on the Cboe S&P 500 BuyWrite Index (BXM), which tracks a monthly at the money covered call on the S&P 500, has found returns broadly similar to the index over long periods with lower volatility, though it lagged in strong bull markets. See Theta Harvesting.

Choosing a strike#

Many traders pick a strike around 0.20 to 0.35 delta, or a price they would be happy to sell at. See Delta.

Choosing an expiration#

Shorter expirations (2 to 6 weeks) decay faster and allow more frequent adjustment; longer ones collect more premium in total but tie you to the strike longer. See Option Expiration Dates.

Assignment and dividends#

If the call is in the money near an ex dividend date, it may be assigned early and you lose the dividend. Check dates before selling. See Exercise and Assignment and Early Exercise.

Managing a covered call#

• Let it expire if it is out of the money near expiry.
• Buy back the call after most of the premium has decayed, then sell another.
• Roll up and out if the stock rises and you want to keep the shares.
• Accept assignment if you are happy to sell at the strike.

Taxes#

In many countries, assignment is a sale that can trigger capital gains tax, and some covered call rules can affect holding periods. Check local rules. See Trading Taxes and Capital Gains.

Common mistakes#

• Selling calls on stocks you expect to soar.
• Selling calls below your purchase price, locking in a loss if assigned.
• Chasing high premiums on very volatile stocks, which often carry high downside risk.
• Forgetting it is still a long stock position.

Frequently asked questions#

What is a covered call?#

Owning shares and selling a call option on them to collect premium, agreeing to sell the shares at the strike if assigned.

Is a covered call risky?#

The main risk is the stock falling, as with owning shares. The premium cushions small declines, and upside is capped at the strike.

What happens if my covered call is assigned?#

Your shares are sold at the strike price. You keep the premium and any gain up to the strike.

Next, learn the put equivalent in Cash-Secured Put.

Sources#

• Cboe, BuyWrite indices