COVERED CALL
Overview
Own 100 shares and sell an OTM call against them. The premium reduces your cost basis and generates income, but above the call strike your shares will be called away. Think of it as 'renting out' the next increment of upside on shares you already hold.
What it does
You're exchanging potential upside above the call strike for guaranteed income today. The premium received reduces your effective cost basis in the stock. If the stock stays below the strike through expiration, you keep both the stock and the premium. If it rises above the strike, your shares are sold at the strike — you miss out on gains above that level but made income while waiting.
Structure
buy 100 stock + sell 1 call
Setup
- 1.Own (or buy) 100 shares of the underlying stock.
- 2.Open the option chain and select an OTM call above the current stock price.
- 3.Choose an expiration 20–45 days out to maximize theta income.
- 4.Sell 1 Call option — you receive the premium immediately.
- 5.If the stock rises above the strike, your shares may be called away at the strike price.
Max profit
(Strike Price − Stock Cost + Premium Received) × 100. E.g., MSFT: ($340 − $330 + $7.50) × 100 = $1,750.
Max loss
Substantial. Stock could fall to zero: (Stock Cost − Premium) × 100. E.g., $322.50 × 100 = $32,250.
Breakeven
Stock Purchase Price − Premium Received. E.g., $330 − $7.50 = $322.50.
When to use
When you own a stock with a neutral to mildly bullish outlook, implied volatility is elevated, and you're comfortable selling shares at the strike price.
When to avoid
When a strong bullish catalyst is likely (upside is permanently capped). Avoid if the stock is a core long-term holding you cannot sell.
Example trade
Stock: MSFT purchased at $330 Sell 1 MSFT $340 Call at $7.50 (credit $750) Expiration: 30 days Max Profit: ($340 - $330 + $7.50) × 100 = $1,750 (if shares called away) Breakeven: $330 - $7.50 = $322.50 Income generated: $750 regardless of what happens within the range If MSFT stays at $332: Call expires worthless, keep $750 premium, still own shares If MSFT rises to $350: Shares called away at $340; missed $10/share of upside above cap
Common mistakes
- ×Selling the call too close to the current price — giving up too much upside for a small premium.
- ×Writing covered calls on stocks during earnings season — the short call creates a cap right when big moves may occur.
- ×Forgetting that if the stock falls dramatically, the call premium provides only partial protection.
- ×Selling multiple contracts on a stock you have fewer than 100 shares per contract.
- ×Treating covered calls as 'risk-free' — significant downside still exists from the stock position.
FAQ
What happens if my shares get called away?
Your 100 shares are sold at the strike price on expiration day. You keep the premium. If you want to stay invested, you'd need to re-purchase shares.
Can I avoid assignment?
Buy back the short call before expiration to close the position and avoid assignment. This usually costs more the closer the stock is to the strike.
What's the 'Wheel Strategy'?
Selling a cash-secured put to get assigned shares, then selling covered calls against those shares repeatedly — cycling between the two strategies.