Covered calls offer a way to generate income from stocks you already own. In this guide, we'll simplify covered calls, highlight their advantages and disadvantages, provide easy-to-follow examples, and answer the most common questions about this strategy.
A covered call involves owning shares of a stock and selling ("writing") call options against those shares. This generates an income (premiums) but caps your upside potential. This means that if the stock price rises significantly, your profit will be limited to your strike price.
Imagine you own a car that’s currently worth $20,000. You’re happy with it, but you’re also okay with selling it for $25,000.
So you strike a deal with someone: “If my car ever hits $25,000 in value within the next 6 months, you have the right to buy it from me at that price – but you have to pay me $150 today for that right.”
The $150 is a premium you pay to acquire that contract agreement.
If your car is worth $30,000 during the 6 months period, the buyer can now exercise the right to purchase it at $25,000.
If your car is worth $20,000 during the 6 months period, the buyer probably will not exercise the right to purchase it at $25,000 because it’s unprofitable for the buyer. In this case, you earn the premium($150) and retain ownership of the car.
Imagine you bought 100 shares of a company XYZ a few years ago at $10 per share. Today, the stock is now trading at $20. But you now consider it overvalued, and there’s no growth driver on the horizon in your opinion. It’s still a good company but just not a great buy at this price. You’re probably only holding on only because you already own it and it’s not extremely overpriced.
You’re comfortable parting with your shares if needed, and selling calls lets you generate extra income while you wait.
Bid – This is the price someone is currently willing to pay you if you want to sell that call option. Think of it like: “I’ll buy this option from you for $0.15”
Ask – This is the price someone is currently offering to sell you a call option for. If you want to buy, you’ll pay this price. Think of it like: “I’ll sell you this ticket for $0.21”.
Last – This shows the most recent price that someone actually paid to buy or sell this option.
IV (Implied Volatility) – This tells you how much the market expects the stock to move in the near future. Higher IV = more uncertainty (or excitement). Lower IV = calmer expectations.
Strike Price – This is the agreed price at which the buyer of the call can buy the stock from you (if the option is exercised). Example: A strike of $25 means they can buy the stock from you at $25, even if it’s trading at $28 or above.
Before we dive into the possible outcomes, let’s start by looking at the Bid column of the image — this represents the price you’d receive if you sell a call option, which is what you’d do in a covered call strategy. Let’s say you decide to sell a call option with a $25 strike price (as shown in the table above). For your 100 shares of Company XYZ, you’d collect $15 ($0.15 * 100) in premium income . From here, there are two possible scenarios that can happen when you sell a covered call — and we’ll walk you through both.
If the stock climbs past your $25 strike price, let’s say it hits $30. The option buyer is likely to exercise their right to buy your shares at $25. This means you’re obligated to sell your shares at $25, even though the market price is now higher.
✅ You keep the $15 premium
✅ You sell the stock at $25, locking in your profits since you bought the shares at $10.
❗However, you miss out on gains beyond $25, since your upside is capped.
If the stock goes sideways or even dips—say it stays at $20 or drops lower. The option will expire worthless. The buyer won’t want to exercise the option to buy your shares at $25 when they can get them cheaper in the market.
✅ You keep your 100 shares,
✅ You pocket the $15 premium
✅ You might also earn dividends if any were paid during the month.
❗However, your shares now lose value as the price has dipped
In this scenario, your position remains intact, and you’ve earned extra income on top of holding the stock.
Advantages:
Disadvantages:
Want a more capital-efficient way to use this strategy? Explore Poor Man’s Covered Calls, a lower-cost alternative using the same principles of covered calls with less upfront investment.
Covered call writing is the act of selling a call option on a stock you already own. By doing so, you agree to potentially sell your shares at a specific price (the strike price) if the buyer chooses to exercise the option before expiration. In return, you collect a premium upfront — which becomes income. It’s called “covered” because your existing shares cover the obligation if you’re assigned.
Yes, it’s possible to sell call options without owning the underlying shares. Also known as selling a naked call which carries high risk. As you don’t own the shares. If the option is exercised, you’re forced to buy the stock at the market price and sell it lower at the strike price. Most brokers don’t allow beginners or low-margin accounts to sell naked calls due to the high risks involved with it.
To sell a covered call, you must own at least 100 shares of the stock. If you have only 80 shares, you are only partially covered. This means that you have to purchase the remaining stock based on market price if the option you are selling is exercised.
A short covered call is simply another name for the covered call strategy. “Short” refers to the fact that you’re short (i.e., you sold) a call option. It’s "covered" because you own the stock that backs the call option. This combination allows you to generate income while limiting risk compared to an uncovered or naked call.
A qualified covered call is a specific type of covered call that meets IRS rules for favorable tax treatment, especially in the U.S. To qualify, the call option must meet certain criteria — such as having a strike price not too far below the current stock price and a minimum holding period. This distinction is mainly relevant for investors trying to preserve long-term capital gains treatment while using the covered call strategy.
If your covered call is assigned, it means the buyer of your call option has chosen to exercise their right to purchase your shares at the strike price. You’ll be obligated to sell your 100 shares per contract at that price, regardless of the current market value. Assignment typically happens when the stock price is above the strike price near expiration or right before a dividend is paid. You still keep the premium you received.
When a covered call is exercised, your shares are automatically sold at the strike price to the call buyer. This can happen at any time before expiration. If this occurs, you’ll no longer own the stock — but you keep the premium collected, and your profit (or loss) depends on your original cost basis and the strike price.
Covered Call: You own 100 shares first, then sell call options against those shares later.
Buy-Write: You buy 100 shares and sell call options at the exact same time as one combined trade.
They’re essentially similar, but the timing and execution differ slightly. Investors that already own 100 shares may have bought it at a lower price instead of a trader that enters the market with a buy-write. This will essentially affect the calculation of the breakeven point and profit.