Covered Calls: Generating Income While Holding Stocks
Introduction
Want to earn extra cash from stocks you already own? The covered call strategy lets you “rent out” your shares for a premium, boosting returns in neutral or slightly bullish markets. In this post, we’ll explain how covered calls work, their risks and rewards, and when to use them, with a real-world example to bring it to life.
How Covered Calls Work
You own 100+ shares of a stock and sell a call option against them, collecting a premium upfront. If the stock stays below the strike price, the call expires worthless, and you keep the premium. If it rises above, you may sell your shares at the strike, capping your upside but still profiting from the stock gain plus premium.
When to Use It
Use covered calls when you expect a stock to trade flat or rise modestly. It’s ideal for long-term holdings where you’re happy to sell at a higher price or want extra income while waiting. For example, sell a call on a stable stock like Apple to pocket premiums monthly.
Real-World Scenario
You own 100 Apple shares at $150 and sell a $155 call for $2 (30 days). If Apple stays below $155, you keep the $200 premium. If it hits $160, you sell at $155 (gaining $5/share + $2 premium = $7/share), but miss the extra $5 upside. If Apple drops, the premium cushions losses slightly.
Risks and Rewards
- Reward: Limited to stock gains up to the strike plus premium.
- Risk: Same as owning the stock, with the premium offering a small buffer. You lose big if the stock crashes, and upside is capped if it soars.
- Pros: Easy income, slight downside protection, simple to execute.
- Cons: Caps gains, minimal protection against large drops, requires owning 100 shares.
Conclusion
Covered calls are a beginner-friendly way to enhance stock returns, perfect for stable markets. By understanding the trade-offs, you can use them to generate consistent income. Next, we’ll explore protective puts for hedging your portfolio!
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