How do covered call options work

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Options Strategy Guide. Develop an options trading plan. Please enter a valid e-mail address. Definition of a Covered Call Strategy. Stock Ownership vs. Covered Calls. Covered Calls and Taxes. Pros and Cons of Covered Calls. What It Means for Individual Investors. By TJ Porter. TJ Porter has over seven years of experience writing about investing, stocks, ETFs, banking, credit, and more.

TJ has a bachelor's in business administration from Northeastern University. Learn about our editorial policies. Fact checked by Hans Jasperson. Article Fact Checked December 18, Hans Jasperson has over a decade of experience in public policy research, with an emphasis on workforce development, education, and economic justice.

His research has been shared with members of the U. Congress, federal agencies, and policymakers in several states. Reviewed by Samantha Silberstein. Article Reviewed July 12, She spends her days working with hundreds of employees from non-profit and higher education organizations on their personal financial plans. Learn about our Financial Review Board. Note The premium that the buyer pays depends on multiple factors.

Important With a covered call, the worst-case scenarios are that you have to sell shares that you own; or, the shares you own lose all of their value less the premium you earned.

You also forgo any potential gains from future share price increases. Pros Generate additional income from shares you own.

Help you set a target selling price for stock you own. Losses are finite compared to other riskier options trading strategies. Cons Limit your potential gains from any future stock price increases. Must continue owning the stock until your options expire.

Net gains are subject to capital gains taxes. Key Takeaways Covered calls let you generate additional income from a portfolio of stocks. Covered calls are low-risk because you own the shares involved in the option. In the worst-case scenario, you lose out on potential gains past the strike price of the call contract.

Covered calls are best for long-term investors who own shares in stable companies. If a stock skyrockets, because a call was written, the writer only benefits from the stock appreciation up to the strike price, but no higher. In strong upward moves, it would have been favorable to simply hold the stock and not write the call.

While a covered call is often considered a low-risk options strategy, that isn't necessarily true. While the risk on the option is capped because the writer owns shares, those shares can still drop, causing a significant loss.

Although, the premium income helps slightly offset that loss. This brings up the third potential downfall. Writing the option is one more thing to monitor. It makes a stock trade slightly more complicated and involves more transactions and more commissions.

The covered call strategy works best on stocks where you do not expect a lot of upside or downside. Essentially, you want your stock to stay consistent as you collect the premiums and lower your average cost every month. Remember to account for trading costs in your calculations and possible scenarios.

Like any strategy, covered call writing has advantages and disadvantages. If used with the right stock, covered calls can be a great way to reduce your average cost or generate income.

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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Table of Contents Expand. Options Basics. How a Covered Call Can Help. When to Use a Covered Call. What to Do at Expiration. Risks of Covered Call Writing. The Bottom Line. Key Takeaways A covered call involves selling an upside call option representing the exact amount of a pre-existing long position in some asset or stock.

The writer of the call earns in the options premium, enhancing returns when the underlying is in a sideways market. A covered call will, however, limit upside potential, and does not protect against the portfolio losing value in a down market.

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