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.