Buying Covered Calls
The main benefits of a covered call strategy are that it can generate premium income, boost investment returns, and help investors target a selling price above the current market price."}},"@type": "Question","name": "What Are the Main Drawbacks of a Covered Call?","acceptedAnswer": "@type": "Answer","text": "The main drawbacks of a covered call strategy are the risk of losing money if the stock plummets (in which case the investor would have been better off selling the stock outright rather than using a covered call strategy) and the opportunity cost of having the stock "called" away and forgoing any significant future gains in it.","@type": "Question","name": "Is There a Risk If I Sell the Underlying Stock Before the Covered Call Expires?","acceptedAnswer": "@type": "Answer","text": "Yes, this can be a huge risk, since selling the underlying stock before the covered call expires would result in the call now being "naked" as the stock is no longer owned. This is akin to a short sale and can generate unlimited losses in theory.","@type": "Question","name": "Should I Write a Covered Call on a Core Stock Position with Large Unrealized Gains That I Wish to Hold for the Long Term?","acceptedAnswer": "@type": "Answer","text": "It might not be advisable to do so since selling the stock may trigger a significant tax liability. In addition, if the stock is a core position you wish to hold for the long term, you might not be too happy if it is called away."]}]}] Investing Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All Simulator Login / Portfolio Trade Research My Games Leaderboard Economy Government Policy Monetary Policy Fiscal Policy View All Personal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All News Markets Companies Earnings Economy Crypto Personal Finance Government View All Reviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All Academy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All TradeSearchSearchPlease fill out this field.SearchSearchPlease fill out this field.InvestingInvesting Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All SimulatorSimulator Login / Portfolio Trade Research My Games Leaderboard EconomyEconomy Government Policy Monetary Policy Fiscal Policy View All Personal FinancePersonal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All NewsNews Markets Companies Earnings Economy Crypto Personal Finance Government View All ReviewsReviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All AcademyAcademy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All Financial Terms Newsletter About Us Follow Us Facebook Instagram LinkedIn TikTok Twitter YouTube Table of ContentsExpandTable of ContentsWhat Is a Covered Call?Profiting from Covered CallsWhen to Sell a Covered CallAdvantages of Covered CallsRisks of Covered CallsFrequently Asked QuestionsFrequently Asked QuestionsThe Bottom LineOptions and DerivativesStrategy & EducationThe Basics of Covered CallsByAlan FarleyUpdated October 14, 2022Reviewed bySamantha Silberstein Reviewed bySamantha SilbersteinFull Bio LinkedIn Twitter Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA. 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 BoardFact checked bySuzanne Kvilhaug Fact checked bySuzanne KvilhaugFull BioSuzanne is a content marketer, writer, and fact-checker. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies for financial brands.Learn about our editorial policiesA covered call involves a seller offering buyers a call option at a set price and expiration date on a security that the seller owns. Professional market players write covered calls to boost investment income. Individual investors can also benefit from the conservative but effective covered call option strategy by taking the time to learn how it works and when to use it.
buying covered calls
The main drawbacks of a covered call strategy are the risk of losing money if the stock plummets (in which case the investor would have been better off selling the stock outright rather than using a covered call strategy) and the opportunity cost of having the stock "called" away and forgoing any significant future gains in it.
Yes, this can be a huge risk, since selling the underlying stock before the covered call expires would result in the call now being "naked" as the stock is no longer owned. This is akin to a short sale and can generate unlimited losses in theory.
Covered call writing is suitable for neutral-to-bullish market conditions. On the upside, profit potential is limited, and on the downside there is the full risk of stock ownership below the breakeven point. Therefore, investors who use covered calls should answer the following three questions positively.
Covered calls offer investors three potential benefits, income in neutral to bullish markets, a selling price above the current stock price in rising markets, and a small amount of downside protection.
Investors should also be (1) willing to own the underlying stock, (2) willing to sell the stock at the effective price, and (3) be satisfied with the estimated static and if-called returns. Losses occur in covered calls if the stock price declines below the breakeven point. There is also an opportunity risk if the stock price rises above the effective selling price of the covered call.
As with any trading strategy, covered calls may or may not be profitable. The highest payoff from a covered call occurs if the stock price rises to the strike price of the call that has been sold and is no higher. The investor benefits from a modest rise in the stock and collects the full premium of the option as it expires worthless. 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."}},"@type": "Question","name": "Are Covered Calls Risky?","acceptedAnswer": "@type": "Answer","text": "Covered calls are considered relatively low risk. Covered calls, however, would limit any further upside profit potential if the stock continued to rise, and would not protect much from a drop in the stock price. Note that, unlike covered calls, call sellers that do not own an equivalent amount in the underlying shares are naked call writers. Naked short calls have theoretically unlimited loss potential if the underlying security rises.","@type": "Question","name": "Can I Use Covered Calls in My IRA?","acceptedAnswer": "@type": "Answer","text": "Depending on the custodian of your IRA and your eligibility to trade options with them, yes. There are also certain advantages to using covered calls in an IRA. The possibility of triggering a reportable capital gain makes covered call writing a good strategy for either a traditional or Roth IRA. Investors can buy back the stock at an appropriate price without having to worry about tax consequences, as well as generate additional income that can either be taken as distributions or reinvested.","@type": "Question","name": "Is There Such a Thing as a Covered Put?","acceptedAnswer": "@type": "Answer","text": "In contrast to call options, put options grant the contract holder the right to sell the underlying (as opposed to the right to buy it) at a set price. The equivalent position using puts would involve selling short shares and then selling a downside put. This, however, is uncommon. Instead, traders may employ a married put, where an investor, holding a long position in a stock, purchases a put option on the same stock to protect against depreciation in the stock's price."]}]}] Investing Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All Simulator Login / Portfolio Trade Research My Games Leaderboard Economy Government Policy Monetary Policy Fiscal Policy View All Personal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All News Markets Companies Earnings Economy Crypto Personal Finance Government View All Reviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All Academy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All TradeSearchSearchPlease fill out this field.SearchSearchPlease fill out this field.InvestingInvesting Stocks Bonds Fixed Income Mutual Funds ETFs Options 401(k) Roth IRA Fundamental Analysis Technical Analysis Markets View All SimulatorSimulator Login / Portfolio Trade Research My Games Leaderboard EconomyEconomy Government Policy Monetary Policy Fiscal Policy View All Personal FinancePersonal Finance Financial Literacy Retirement Budgeting Saving Taxes Home Ownership View All NewsNews Markets Companies Earnings Economy Crypto Personal Finance Government View All ReviewsReviews Best Online Brokers Best Life Insurance Companies Best CD Rates Best Savings Accounts Best Personal Loans Best Credit Repair Companies Best Mortgage Rates Best Auto Loan Rates Best Credit Cards View All AcademyAcademy Investing for Beginners Trading for Beginners Become a Day Trader Technical Analysis All Investing Courses All Trading Courses View All Financial Terms Newsletter About Us Follow Us Facebook Instagram LinkedIn TikTok Twitter YouTube Table of ContentsExpandTable of ContentsWhat Is a Covered Call?Understanding Covered CallsMaximum Profit and Maximum LossAdvantages and DisadvantagesWhen to Use and When to Avoid ThemExampleCovered Call FAQsThe Bottom LineTradingOptions and DerivativesCovered Calls: How They Work and How to Use Them in InvestingByAkhilesh GantiUpdated June 02, 2022Reviewed by 041b061a72