Covered Calls: Your First Options Strategy for Steady Income

Picture this: You own 100 shares of Apple stock that you bought for $190 each. Apple is now trading at $215, giving you a nice $2,500 paper profit. But the stock has been moving sideways for months, and you're wondering if there's a way to make money while you wait for the next big move.

There is. It's called a covered call, and it might just change how you think about stock investing forever.

This single strategy has helped thousands of investors generate consistent monthly income from stocks they already own. It's often the first options trade beginners make, and for good reason. It's intuitive, relatively safe, and teaches you the fundamentals of options trading without requiring you to buy anything new.

What Is a Covered Call? (The Simple Explanation)

A covered call is like being a landlord for your stocks. Just as a landlord collects rent while still owning property, you collect "rent" (premium) on your stocks while still owning them.

Here's how it works in two simple steps:

Step 1: You own at least 100 shares of a stock (this "covers" your obligation)

Step 2: You sell someone else the right to buy your shares at a specific price by a specific date

In return, you get paid immediately, regardless of what happens to the stock.

Think of it as offering someone a deal: "I'll sell you my Apple shares for $225 anytime in the next month, and you pay me $275 upfront for this option." Whether they take the deal or not, you keep the $275.

A Real-World Example: Apple Covered Calls

Let's say you own 100 shares of Apple trading at $215 per share. You decide to sell a covered call with these details:

• Stock price: $215

• Strike price: $225 (the price you'll sell at if called away)

• Expiration: 30 days from now

• Premium received: $2.75 per share ($275 total)

You immediately collect $275, which you keep no matter what happens.

Now, three outcomes are possible:

Scenario 1: Apple Stays Below $225 (Most Common)

Apple closes at $220 after 30 days. Since the stock never reached your $225 strike price, the option expires worthless. You keep your $275 premium and still own your 100 shares.

Result: You made $275 for doing essentially nothing, and you can sell another covered call next month.

Scenario 2: Apple Rises to $215-225 (The Sweet Spot)

Apple climbs to $227 by expiration. Your shares get "called away", automatically sold at the $225 strike price. You receive $22,500 for your shares ($225 × 100) plus you keep the $275 premium.

Total profit: $1,000 (stock gain) + $275 (premium) = $1,275

Result: You locked in a solid profit and can use the $22,750 to buy shares of another stock or repurchase Apple if you want.

Scenario 3: Apple Skyrockets to $240 (The "Problem")

Apple surges to $240, but your shares still get called away at $225. You miss out on the extra $15 per share ($1,500 total) above your strike price.

Total profit: Still $1,000 (stock gain) + $275 (premium) = $1,275

Result: You made money, but you left money on the table. This is the main risk of covered calls, capping your upside.

Why Covered Calls Are Perfect for Beginners

Reason 1: You Already Own the Foundation

You don't need to learn about buying options, just selling them. Since you own the stock, you're "covered" if anything goes wrong. There's no additional capital required.

Reason 2: Immediate Income Generation

The moment you sell a covered call, cash appears in your account. This premium is yours to keep regardless of what happens next. It's like collecting rent on property you own.

Reason 3: It Teaches Core Options Concepts

Through covered calls, you'll naturally learn about:

• Strike prices (the price you're willing to sell at)

• Expiration dates (when your obligation ends)

• Premiums (the income you collect)

• Assignment (what happens when your shares get called away)

Reason 4: Lower Risk Than Naked Options

Since you own the underlying stock, you're not exposed to unlimited losses. Your risk is limited to the stock declining (which you'd face anyway as a stockholder), minus the premium income you collected.

When Covered Calls Work Best

Market Conditions That Favor Covered Calls:

Sideways markets: When stocks trade in a range, covered calls generate income without the stock getting called away frequently.

Slowly rising markets: Modest upward trends allow you to collect premium while still participating in some stock appreciation.

High volatility periods: When options are expensive due to uncertainty, you collect higher premiums for the same obligation.

Stock Characteristics That Work Well:

Stable, dividend-paying companies: Blue-chip stocks with predictable business models

Stocks you're willing to sell: Don't use covered calls on your "forever" holdings

Liquid options markets: Ensure tight bid-ask spreads for better execution

The Mathematics of Covered Call Returns

Let's examine the potential returns using our Apple example:

Monthly Income Scenario:

• Stock value: $21,500 (100 shares × $215)

• Premium collected: $275

• Monthly return: 1.3% ($275 ÷ $21,500)

• Annualized return: 15.8% (if repeated monthly)

Plus Stock Appreciation:

If Apple appreciates to $225 over the month:

• Stock gain: $1,000

• Premium income: $275

• Total return: $1,275 on $21,500 investment = 5.9% in one month

These returns can be substantial, especially when repeated consistently.

Strike Price Selection: Your Strategic Decision

Choosing the right strike price determines your risk-reward balance:

Out-of-the-Money (OTM) Strikes

Example: Stock at $215, sell $225 calls

• Pros: Room for stock appreciation, lower assignment risk

• Cons: Lower premium income

• Best for: Moderately bullish outlook

At-the-Money (ATM) Strikes

Example: Stock at $215, sell $215 calls

• Pros: Higher premium income

• Cons: Higher assignment probability, no room for stock gains

• Best for: Neutral outlook, maximum income focus

In-the-Money (ITM) Strikes

Example: Stock at $215, sell $205 calls

• Pros: Highest premium income, some downside protection

• Cons: Very likely assignment, limited total returns

• Best for: Slightly bearish outlook, wanting to sell stock anyway

Most beginners start with slightly out-of-the-money strikes to balance income and growth potential.

Common Covered Call Mistakes (And How to Avoid Them)

Mistake 1: Using Stocks You Don't Want to Sell

The problem: Getting emotionally attached when shares get called away

The solution: Only use covered calls on stocks you're willing to part with at the strike price

Mistake 2: Selling Calls Too Close to the Stock Price

The problem: Limiting upside for minimal additional premium

The solution: Give your stocks room to breathe, target strikes 5-10% above current price

Mistake 3: Ignoring Earnings and Dividend Dates

The problem: Unexpected volatility can cause immediate assignment

The solution: Check the calendar before selling calls, especially before earnings announcements

Mistake 4: Chasing High Premiums Without Considering Probability

The problem: High premiums often mean high assignment risk

The solution: Balance premium income with the likelihood of keeping your shares

Mistake 5: Not Having a Roll-or-Assignment Plan

The problem: Panic when shares approach the strike price

The solution: Decide in advance whether you'll roll the option or accept assignment

Advanced Covered Call Techniques

Rolling Your Calls

When your stock approaches the strike price before expiration, you can "roll" your call option:

• Buy back the current call (closing the position)

• Sell a new call with a higher strike or later expiration

• Goal: Avoid assignment while collecting additional premium

The Monthly Routine

Many successful covered call writers establish monthly routines:

1. Review positions 1-2 weeks before expiration

2. Close profitable calls at 50% of premium collected

3. Roll or accept assignment on challenged positions

4. Sell new calls on current holdings

Position Sizing

Don't put all your eggs in one basket:

• Start small: Use 10-20% of your portfolio initially

• Diversify: Use multiple stocks across different sectors

• Scale gradually: Increase size as you gain experience

Building Your Covered Call System

Week 1: Education and Setup

• Choose 2-3 stocks you own in 100+ share lots

• Learn your broker's options interface

• Practice calculating potential returns

• Paper trade if available

Week 2: First Execution

• Sell your first covered call using conservative strikes

• Document everything: strike, premium, expiration, rationale

• Set calendar reminders for key dates

Week 3: Management and Learning

• Monitor your position daily

• Learn about rolling techniques

• Observe how time decay affects option prices

• Plan for various scenarios

Week 4: Review and Optimize

• Calculate actual returns versus projections

• Identify what worked and what didn't

• Adjust strategy based on experience

• Plan next month's approach

Tax Considerations for Covered Calls

Premium income is generally taxed as short-term capital gains, regardless of how long you hold the stock.

If assigned: The sale of your stock may qualify for long-term capital gains treatment if you've held the shares for over one year.

Qualified covered calls: Certain covered calls don't affect the holding period of your stock for tax purposes.

Consult a tax professional for guidance specific to your situation.

Your Covered Call Action Plan

Before You Start:

• Identify stocks you own in 100+ share lots

• Verify your broker allows options trading

• Understand the risks and potential outcomes

• Start with paper trading if available

Your First Trade:

• Choose a liquid, stable stock

• Select a strike 5-10% above current price

• Target 30-45 days to expiration

• Calculate maximum profit and breakeven

Ongoing Management:

• Review positions weekly

• Set profit-taking targets (often 50% of premium)

• Plan for assignment scenarios

• Track performance versus buy-and-hold

The Bottom Line

Covered calls transform stock ownership from a passive waiting game into an active income strategy. While they do cap your upside potential, they provide consistent cash flow and teach valuable options concepts in a relatively low-risk environment.

Start conservatively, learn the mechanics, and gradually build confidence through experience. Many successful options traders credit covered calls as the strategy that opened their eyes to the income-generating potential of options trading.

Remember: The goal isn't to hit home runs, it's to generate consistent singles and doubles while building your options knowledge foundation.

Master covered calls, and you'll have built the foundation for every advanced options strategy that follows.

Quick Reference: Covered Call Checklist

Position Setup:

• Own 100+ shares of target stock

• Stock has liquid options market

• Willing to sell shares at strike price

• No earnings within 2 weeks

Strike Selection:

• Choose strike 5-10% above current price

• Target 30-45 days to expiration

• Calculate maximum profit potential

• Consider assignment probability

Management:

• Monitor position weekly

• Close at 50% profit when possible

• Plan roll strategy if challenged

• Accept assignment if economically favorable

Master this foundation strategy, and you'll be ready for the entire world of options trading that awaits.

Probabilities over predictions,

Andy Crowder

Want More Options 101 Lessons?

This article is part of our Options 101: First Steps to Trading series at The Option Premium, designed to build a rock-solid foundation for options traders.

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