Covered Calls (Education): How It Works, Rules & Example
A covered call means owning shares and selling a call option on them to collect a premium. It can add income, but it caps your upside and does not protect much against a falling share price.
How it works
- Own at least 100 shares of a stock or ETF, since one option contract usually covers 100 shares.
- Sell a call option with a strike price above the current price and an expiry a few weeks or months out.
- Collect the premium immediately as income.
- If the price stays below the strike at expiry, you keep the shares and the premium.
- If the price rises above the strike, your shares may be sold at the strike price.
The rules
👍 Pros
- Generates extra income from shares you already own.
- Premium provides a small cushion against modest price dips.
- Clear, defined outcomes at expiry.
👎 Cons
- Caps your gains if the stock rises sharply.
- Offers little protection in a large decline.
- Options involve complexity, fees and tax considerations.
- Requires options approval from your broker.
Worked example
Common mistakes
- Selling calls on a stock you would hate to lose.
- Choosing strikes too close to the current price just for higher premiums.
- Forgetting about upcoming earnings or dividends that can affect assignment.
Tools for this strategy
FAQ
What does covered mean?
It means you own the shares underlying the call you sold, so you can deliver them if assigned.
Can I lose money with covered calls?
Yes. If the stock falls more than the premium you received, you lose money on the position.
What happens at expiration?
If the price is below the strike, the option usually expires worthless. If above, your shares are typically sold at the strike.
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