Why Covered Calls Could Be Bad for Your Trading Strategy

Covered calls is an options strategy for generating income from stocks you own. However, even if you’re an intermediate trader who understands the basics of covered calls, it’s important to recognize their potential downsides. In this guide, let's explore how covered calls work and why investors use them, then dive into the drawbacks – such as capped profits, assignment risk, capital tie-up, and volatility impact. 

Potential Drawbacks of Covered Calls

Covered calls often come with lopsided returns—your upside is capped by the short call, but your downside remains fully exposed. This means that while you collect a small premium, your profit is limited even if the stock rallies, yet you still absorb large losses if the stock drops significantly. This payoff imbalance makes the strategy less suitable in volatile markets or when you expect strong upside.

Covered calls may not be ideal if you anticipate a strong rally, as they limit your upside beyond the strike price. This strategy is also less suitable for traders who prefer to hold their shares long-term or require greater flexibility in managing their portfolio.

Limited Profit Potential

Selling a call caps your gains. If the stock surges, you won’t benefit beyond the strike price plus premium. This makes the strategy less attractive for high-growth or volatile stocks.

Risk of Stock Assignment

If the stock moves above the strike, you may be forced to sell your shares and forced to sell your shares. This can disrupt long-term plans, causing missed dividends. Early assignment is also possible, especially around dividend dates.

Capital Requirements

Covered calls require owning 100 shares, which ties up significant capital. This can lead to:

• High Upfront Costs
• Opportunity Cost
• Lack of Diversification

This strategy might not be practical for smaller accounts or traders seeking higher capital efficiency.

Impact of Market Volatility

Covered calls work best in stable markets. High volatility increases risks:

• Big Drops: Premiums won’t offset large stock losses.
• Sharp Rallies: You’ll miss gains due to the cap.
• Whipsaws: Frequent adjustments might be needed, reducing returns and increasing stress.
  
  
  

When Covered Calls Still Make Sense

It’s not all bad with covered calls. In every Options trick up your sleeve, there are pros and cons. With covered calls you essentially collect a premium upfront, and if the stock stays below the strike price, the option expires worthless and you keep the premium. If the stock rises above the strike, you're obligated to sell the shares at the strike price, capping your upside.

Covered calls still serve a purpose in the right market context, especially when your objective isn’t chasing explosive growth but generating steady cash flow from stocks you already own.

Why do Investors Consider Covered Calls?

• Income Generation: Great for flat or slowly rising stocks, offering a steady premium income.

• Mild Downside Cushion: The premium provides a small buffer if the stock dips slightly.

• Neutral to Slightly Bullish Outlook: Ideal when you expect modest stock movement.

• Strategic Exit Plan: Can help sell a stock at a desired target while collecting income.

Understanding traders psychology before entering a covered call trade is just as important as understanding the mechanics. If you're not clear on your goals, whether it's income, growth, or long-term holding — the strategy can end up working against you. Clarity of intent keeps your trades aligned with your bigger picture.

Alternative Options Trading Strategies

Poor Man’s Covered Call

A PMCC uses a long-term deep-in-the-money call (LEAP) as a stock substitute and sells short-term calls against it. Benefits include:

• Lower Capital Requirement

• Defined Max Loss

• Similar Income Potential

It requires more management but offers a capital-efficient way to generate income with defined risk.

Other Options Strategies

• Collars: Combine a long stock, short call, and long put. Limits both upside and downside for more protection.

• Bull Call Spread: A bullish strategy using two call options to profit from moderate upside with defined risk.

• Bear Call Spread: A neutral-to-bearish strategy that earns income by selling a call and buying a higher strike call to limit risk.

These strategies offer more flexibility depending on your market outlook and risk tolerance.

Closing Thoughts about the Cons of Covered Calls 

Every options strategy comes with its pros and cons, but what sets great traders apart is their ability to choose the right approach for current market conditions. When volatility and uncertainty hit, it’s the well-prepared trader who stays ahead.

Mastering options trading isn't about chasing every opportunity—it's about sharpening your axe. At Piranha Profits, we believe in empowering traders with the right knowledge and skills to make confident, well-timed decisions. The more you understand each strategy’s risk and reward, the better equipped you are to adapt and grow your portfolio with purpose and intent.

FAQs

Why might a covered call not be a good strategy?
Because it caps your upside, provides minimal downside protection, and requires significant capital. It may not align with your goals if you're seeking growth or better risk/reward trades.

Can you lose money with covered calls?
Yes. Stock losses can easily exceed the premium received, especially in downturns. The strategy doesn’t fully hedge downside.

Why is my covered call losing value?
Likely because the stock dropped or surged past your strike, making the call more expensive to close or showing net losses overall.

Do covered calls expire worthless?
Only if the stock stays below the strike. That’s the ideal outcome, but it's not guaranteed.