What Is a Covered Call?
In plain English
A covered call is an options strategy in which an investor who owns shares of a stock sells (writes) call options against that position. The seller collects a premium upfront, generating income, but agrees to sell the shares at the strike price if the option is exercised, effectively capping the upside potential.
How Does a Covered Call Strategy Work?
You own 100 shares of a stock and sell one call option contract (each contract covers 100 shares) at a strike price above the current market price. You collect the premium immediately. If the stock stays below the strike at expiration, you keep your shares and the premium. If it rises above the strike, your shares may be called away at that price.
When Is a Covered Call Strategy Most Effective?
Covered calls work best in flat to moderately bullish markets. If you believe a stock will move sideways or rise slightly, selling calls lets you earn income on a position that might otherwise generate no returns. The strategy is popular among income-oriented investors and retirees seeking to supplement dividend income.
What Are the Risks of Covered Calls?
The primary risk is opportunity cost — if the stock surges past the strike price, you miss the gains above that level. You also still bear full downside risk on the shares you own; the premium provides only a small cushion. Covered calls are considered conservative for an options strategy but are not risk-free.
Frequently asked questions
How much income can you earn from covered calls?
Income varies based on the stock's volatility, time to expiration, and strike price selection. Annual yields from a systematic covered call strategy typically range from 3% to 10% of the position value, though results vary significantly by market conditions.
Are covered calls taxed as income or capital gains?
Premiums received from covered calls are generally taxed as short-term capital gains. If the option is exercised and shares are sold, the premium is added to the sale proceeds and the entire transaction is taxed based on your holding period for the underlying shares.
Keep exploring
Related terms
Options Trading
Options are financial contracts that give you the right, but not the obligation, to buy or sell an asset at a specific price before a set expiration date. Options can be used for speculation, hedging, or income generation.
Dividend
A dividend is a portion of a company's profits paid out to shareholders, typically on a quarterly basis. Dividends provide investors with regular income in addition to any stock price appreciation.
Stock
A stock represents a share of ownership in a company. When you buy stock, you become a part-owner of that business and can benefit from its growth through price appreciation and dividends.
Yield
Yield is the income generated by an investment expressed as a percentage of its cost or current value. It is a key metric for evaluating bonds, dividend stocks, REITs, and other income-producing investments.
Derivatives
Derivatives are financial contracts whose value is derived from an underlying asset, such as stocks, bonds, commodities, or interest rates.