The covered call is the most widely used options income strategy: you own 100 shares of a company, then sell a call on them. You collect the premium in cash in your account right away, and you agree to sell your shares at the strike price if asked.
| You own | 100 shares of MSFT at $415 |
| You sell | A call with a $425 strike price expiring in 30 days |
| Premium collected | $3.20 = $320 in cash right away |
| Downside breakeven | 415 − 3.20 = 411.80$ |
| Max profit | (425−415+3.20)×100 = 1,320$ |
The three possible outcomes
- The stock stayed below $425: The contract expires worthless, so you keep your shares and the $320 premium. This is the outcome a seller wants when the goal is to hold the stock.
- The stock rose above $425: Your shares are called away at $425, so your effective sale price is $428.20 with the premium, and you miss any gain above that.
- The stock fell sharply: The premium offsets only $3.20 per share of the loss. It is not protection against a decline.
How much does it pay relative to the value of the shares?
A premium of $320 on shares worth $41,500 is about 0.77% in 30 days. If it repeated on the same terms every month, it would come to about 9.4% a year, but the terms never repeat exactly: the premium changes with volatility and the stock price.
How do you choose the strike price and the expiry?
- A strike closer to the stock price: a bigger premium, and a higher chance your shares are called away.
- A farther strike: A smaller premium, and more room for the stock to rise before you are asked to sell it.
- Expiry: Many sellers pick contracts that expire in 30 to 45 days, because the time value of the contract decays fastest there, in the seller's favor.
When a big rise in the stock is expected: the profit above the strike price goes to the option buyer. And just before an earnings release: the stock may jump above the strike price and the shares are delivered before you can decide anything.
Common mistakes
- Selling the option on a stock you would not want to hold if it falls: the premium is small against a sharp drop.
- Forgetting dividends: a call that is in the money can be exercised early, before the dividend date, and your shares are called away before it is paid.
Summary
A covered call turns shares you own into regular premium income, in exchange for a cap on profit at the strike price. It suits a stock you expect to stay flat or rise moderately, and it protects you from a drop only by the amount of the premium. Before selling, ask three questions: am I willing to sell my shares at this price? For how long? And is there an earnings release or dividend before expiration?
