If you already own stocks in your portfolio, you may be able to use those shares to generate additional income through a strategy called a Covered Call.
With a covered call, you sell a call option against shares you already own and receive an upfront payment called the premium. In exchange, you agree to sell your shares at a predetermined price if the option is exercised.
Here is how covered calls work, why traders use them, and what you should understand before placing your first trade.
What Is a Covered Call?
A covered call is a two-part options strategy:
You own the required number of shares of a stock or ETF.
You sell a call option against those shares and collect the premium.
Because you already own the underlying shares, the call is considered “covered.”
If the stock rises above the option’s strike price and the option is exercised, your shares may be sold at the agreed strike price. Since you already own the shares, you are not exposed to the same theoretically unlimited loss associated with an uncovered or “naked” call.
However, a covered call still carries risk because the stock itself can decline significantly, and your potential upside is limited above the strike price.
How Covered Calls Generate Income
When you sell a call option, you receive the option premium upfront.
That premium belongs to you, although the overall trade can still result in a loss if the underlying stock falls substantially.
A Quick Example:
You own 100 shares of Company XYZ trading at $50 per share.
You sell a $55 strike call expiring in 30 days for a premium of $1.50 per share.
With 100 shares, you receive $150 in premium ($1.50 × 100).
You now have an obligation to sell your 100 shares at $55 if the option is exercised.
The 3 Possible Outcomes at Expiration
Once you sell the call, the outcome will depend mainly on where the stock price finishes relative to the strike price.
1. Stock Stays Below $55
If XYZ remains below $55 at expiration, the call may expire worthless.
You keep your 100 shares and the $150 premium. If your strategy allows, you can potentially sell another call for a future expiration.
2. Stock Rises Above $55
If XYZ rises above $55 and the call is exercised, your shares may be sold at $55 per share.
You keep the $150 premium and also receive a $500 gain from the stock moving from $50 to $55.
Ignoring fees and taxes, the total gain would be:
$500 stock gain + $150 premium = $650
However, you would not participate in additional stock gains above the $55 strike price.
3. Stock Drops Significantly
If XYZ falls substantially, you still keep the $150 premium, which provides a small cushion against the stock decline.
For example, if the stock falls from $50 to $40, your shares lose $1,000 in value. The $150 premium reduces the overall loss to approximately $850, before fees and taxes.
This shows an important point: a covered call does not protect you from a major decline in the underlying stock.
Best Practices for Covered Calls
If you are considering covered calls, keep these practical points in mind:
Choose stocks you are comfortable holding: Only sell calls on stocks you would be willing to own even if the price falls. The premium does not eliminate the risk of holding the stock.
Choose an appropriate strike price: Out-of-the-money (OTM) strikes can provide some upside room, but choosing a strike means accepting that your shares may be sold at that price if the option is exercised.
Consider the expiration carefully: Many traders use expirations around 30–45 days, but there is no universal best timeframe. Compare premium, time decay, volatility, liquidity, and your investment objective before choosing an expiration.
Key Takeaway
Covered calls can turn existing stock holdings into a potential source of additional premium income.
They can be useful when you are willing to sell your shares at a predetermined price and have a neutral to moderately bullish outlook on the stock.
But remember: the premium is not free money. You give up some upside potential, while still carrying most of the downside risk of owning the stock.
Disclaimer: Options trading involves significant risk and is not suitable for all investors. This content is provided strictly for educational purposes and should not be considered financial advice.