Covered Calls, Explained: How Income Investors Use Them
A covered call is one of the most widely used options strategies for investors who own stock. Here is how it works, where it fits, and what it costs you, with links to our in-depth guides on each topic.
What a covered call is
When you sell a covered call, you own at least 100 shares of a stock and sell one call option against them. The buyer pays you a premium up front. In exchange, you agree to sell your 100 shares at a set price (the strike) if the buyer exercises the option before it expires. Because you already own the shares, the call is "covered."
The premium is yours to keep whatever happens next. That is why covered calls appeal to investors who want their holdings to produce cash flow in addition to dividends or price appreciation. Our complete covered calls guide goes deeper on every part of the strategy.
A simple example
Say you own 100 shares of a stock trading at $50. You sell one 30-day call with a $55 strike and collect $1.00 per share, or $100. Three things can happen by expiration:
- The stock stays below $55. The option expires worthless. You keep your shares and the $100, and you can sell another call.
- The stock rises above $55. Your shares are likely called away at $55. You keep the $100 premium plus the gain from $50 to $55, but you give up any rise above $55.
- The stock falls. You still own the shares. The $1.00 premium lowers your break-even to $49, but below that you carry the loss, just as any stock owner would.
Hypothetical example for illustration only; not a recommendation. Commissions and taxes are not included.
Work through the math in covered call break-even analysis and see what happens after your shares are called away.
Choosing the strike and the expiration
The two biggest decisions are how far out of the money to sell the call and how far out in time. A strike closer to the current price pays more premium but is more likely to be exercised; a strike further away pays less and leaves more room for the stock to rise. Many traders use an option’s delta as a rough gauge of that trade-off. Shorter expirations decay faster but need more frequent management.
Read the delta selection guide, how to approach expiration date selection, and the best time to sell covered calls.
Managing the trade
A covered call is not "set and forget." When the stock moves, you may buy back the call, roll it to a later date or a different strike, or let the shares go. Having rules for those decisions before you place the trade is what turns a single trade into a system.
See our guide to rolling covered calls, covered call adjustments and covered call exit strategies.
The risks and trade-offs
Covered calls cap your upside while the call is open, and they do not protect you from a falling stock beyond the premium you collected. Assignment can come earlier than you expect, especially around dividends, and premium income has tax consequences in a taxable account.
Before you start, read covered call risk management, the most common covered call mistakes to avoid, and how covered call income is reported on your 1099.
Covered calls in retirement accounts
Many brokers allow covered calls in IRAs, which makes the strategy popular with investors who are retired or getting close. Rules differ by broker and account type. Learn more about covered calls in an IRA and using covered calls for retirement income.
