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Covered Calls

Selling covered calls, or writing covered calls, is one of the more conservative strategies in trading options. It is suitable for new investors to earn additional income and have some control over your positions. As always, risk is involved and experience can only be gained through education and real trades. The advice is based from my limited experience with option trading.

Getting Started

Nothing beats practical and real experience. First, I recommend you to get a practice account with virtual money and test out a few trades. The purpose is to familiarize yourself with the process and terminology. Second, start selling your first call on a safe, large-cap stock with dividend, maybe one of the Dividend Aristocrats. The reason is that volatility on this stock is likely low and in the worst case the stock price goes down, you will continue to own the stock and earn your first option premium and still have some dividends over your holding period. For your practice account, OptionsHouse offers virtual accounts that can trade stocks and options.

Covered Call Evaluator

This covered call evaluator is designed specifically for covered calls. It will help you answer these important questions:

Tips - Good Habits

Tips - Bad Habits

Good Example - Selling Covered Call on an OVER-BOUGHT position

Let assume you have a really good stock that you keep for dividend. You bought it a while ago and your cost basis is low enough from the current price. I skip tax implications for long/short term and qualified calls here for simplicity. You don't expect this stock to go any higher than the strike price and it is current overbought. Because it is overbought, the recent price has gone up really quick and you are expecting a correction to be coming but is still above your cost basis. At this time, the option premium is high. You should sell an out-the-money covered call on this stock. Thus, you have the best of both worlds: high/peak premium from selling the option now and still get to keep the stock when the call expires. This is NOT a buy/write approach. With buy/write, you're also buying at the high end and the safety threshold above break-even is small. If the stock corrects significantly, you will be at a loss. This is a write-only approach on your existing position.

Of course there are risks associated with this case:

Bad Example - Selling Covered Call on an OVER-SOLD position

If you're impatient and just wish to break even so you sell a call when the stock is still in a down trend, or it is currently oversold. The premium receives likely very small and more importantly, smaller than selling it at a more stable/positive trend. A better approach would be wait until there are some positive news/events on this stock to sell covered call.

Good Example - Selling Covered Call during HOLD-and-WAIT

You bought a stock and it is carrying a loss. You can either exit the position now or wait for it to recover. If you believe in this stock and plan to wait, you can sell covered calls to earn income while you wait. It also reduce the pain and reduce your cost basis. However, timing the covered call is important.


There are other cases, scenarios, approaches, exceptions that I do not cover or discuss. Please feel free to send me feedback and your own examples to include here.