What is a Covered Call?

Covered calls are another way to generate income inside of your stock portfolio. How much you generate is all up to your risk tolerance, but covered calls can be a great tool to add to you trading toolbelt. Essentially a covered call is a an agreement between you and another investor where you are agreeing to sell your stock in exchange for premium (also called a credit).

How does a covered call work?

Covered calls are a relatively simple concept. Once you understand how they work, I have no doubt that you will absolutely love them. First we need to touch on the requirements to sell covered calls.

• 100 shares of a stock (or a long call, but we will cover that in another article)
• Option privileges within your brokerage account

Now that you meet the requirements to sell covered calls, lets get into what a covered call looks like. In this example you own 100 shares of Square (ticker SQ). When you open a covered call position you are agreeing to sell your stock at a given strike price, by a given date, if the stock price is above your strike price. In exchange you get compensated with premium. The buyer of the corresponding option call gives you a set amount of premium to compensate you for your risk. After all, you are potentially risking all of your future capital gains from your specific stock. I know that sounds confusing, but lets run through the numbers.

In this example, your strike price is $65, your expiration date is 7/22/2022, and the premium you receive is $100. Premium is always figured up in 100ths. So if the option says you recieve$1.00, that means you receive $1.00 per share, or $100.

The best part about covered calls is that you get to pick all the terms of the transaction. You pick your sale price, your sale date, and how much premium you are compensated with. Sounds like a pretty good deal right? Well, unfortunately there is one pretty big risk that you take, that is future gains. Lets take the above example again. Lets say that by 7/22/2022 the underlying stock is at $70, or $5 above your strike price. Even though the underlying stock is at $70, you still have to honor your contractual agreement and sell the stock at $65 when the market closes. There is a way you can avoid this assignment though.

Now, in reality, you should only pick a strike price that you are comfortable selling the underlying stock at. But, you can also consider rolling your position. When you roll your position you simply roll your expiration date from your current date to some date in the future. Doing this will not only buy you more time, but can also allow you to roll your strike price up, and potentially receive another credit (premium) for the added time.

In the event that you get assigned and have to sell your stock position you can always start selling cash secured puts on the underlying stock as well. Check out the article located here to find out more on cash secured puts.