So, you’ve been saving money for a while, throwing it into random stocks you read about on Motley Fool or r/wallstreetbets. You’re in it for the long haul, but the stocks just aren’t growing fast enough to wet your palate. This is when you sell covered calls to augment your gains.
Covered calls are a great way for traders to generate consistent cash flow while holding shares they already town. This strategy involves selling call options on shares you own, allowing you to collect a premium while still benefiting from stock growth up to the strike price.
How Covered Calls Work
To sell a covered call, you must own at least 100 shares of a stock. You then sell a call option, which gives the buyer the right to purchase your shares at a set price (the strike price) before the option expires. In return, you receive a premium, which is yours to keep no matter what happens.
Why Covered Calls Are a Great Strategy
- Extra Income: Make a little extra money (from premiums collected) from the stocks you already own.
- Downside Protection: The premium acts as a buffer against minor stock declines.
- Controlled Risk: Since you already own the shares, you’re not exposed to unlimited downside like other option strategies. If the stock goes down, just hold on to it and wait (or hope) it comes back up.
Potential Gains on Top of Growth
Let’s say you own 100 shares of a stock trading at $50. You sell a covered call with a strike price of $55 and receive a $2 premium per share. There are three possible outcomes:
- Stock Stays Below $55: The option expires worthless, and you keep the $2 premium ($200 total), plus any dividends.
- Stock Reaches $55: Your shares are called away, but you still profit from both the $5 stock increase ($500) and the $200 premium, for a total gain of $700. [describe how this does cap upside potential]
- Stock Drops: The premium offsets some of the loss, reducing your breakeven price to $48 ($50 – $2).
Pick Your Pay Schedule: Weekly, Monthly, or..?
One of the best parts about covered calls is deciding how often you collect income. When you sell a call, you choose its expiration date:
- Weekly – Frequent payouts and flexibility but requires more management. Great for people who like to pretend they’re “day traders.”
- Monthly – Higher premiums with less effort. A solid balance, though predicting price movement over a month can be tricky.
- Long-Term (LEAPS) – Big upfront premiums but locks you in for months or longer. If the stock tanks and you want to sell, you’re stuck unless you close the option at a loss.
Pick based on how often you want to get paid and how much control you want over your shares.
Final Thoughts
Covered calls are a great way to generate steady income while holding stocks you believe in for the long run. Sure, they cap your upside if the stock skyrockets, but in exchange, you get consistent cash flow and some downside protection.
Which stocks should you sell covered calls on? The ones you already own. But if you need help picking stocks that work well for this strategy, that’s a topic for another time.