Key Takeaways
- Sell call option on owned stock for premium income.
- Provides limited downside protection with capped upside.
- Best for neutral to moderately bullish outlooks.
What is Covered Call?
A covered call is an options strategy where you own at least 100 shares of a stock and sell a call option on those shares, collecting an earned premium as income. This approach allows you to generate additional yield on your existing stock holdings while agreeing to sell the shares at a set strike price if the option is exercised.
This strategy is popular among investors seeking income and moderate risk management through partial hedge protection, especially in sideways or mildly bullish markets.
Key Characteristics
Covered calls combine ownership with options selling to create income and limited risk exposure. Key points include:
- Stock ownership required: You must own the underlying shares before selling calls, typically in lots of 100 per option contract.
- Premium income: You collect an upfront earned premium that provides a cushion against minor price declines.
- Limited upside: Your maximum profit is capped at the strike price plus premium, sacrificing potential large gains.
- Risk management: It acts as a partial hedge by offsetting losses but does not fully protect against steep stock drops.
- Flexibility: You can roll or adjust options based on market outlook or repeat the strategy if unexercised.
How It Works
To implement a covered call, you first own shares of a company like JEPI or other dividend-focused stocks. Then you sell a call option contract specifying a strike price and expiration. You immediately receive the option premium, which adds income regardless of how the stock performs.
If the stock price stays below the strike at expiration, the option expires worthless, letting you keep both your shares and the premium. If the stock price exceeds the strike, the option is exercised, and you sell your shares at the strike price, keeping the premium but giving up additional upside.
Examples and Use Cases
Covered calls are well-suited for income-oriented investors and can be applied across various industries and market conditions. For instance:
- Airlines: Long-term holders of Delta or American Airlines shares might sell covered calls to generate income amid fluctuating travel demand.
- Dividend stocks: You can enhance yield on stocks featured in best dividend stocks for beginners by selling covered calls as part of a conservative income strategy.
- ETFs and income funds: Strategies like those employed by JEPI use covered calls to provide consistent monthly dividends, appealing to retirees or income-focused investors.
Important Considerations
While covered calls can boost your portfolio income, they come with trade-offs. The capped upside means you may miss out on large price gains, and you still face downside risk if the stock declines significantly. Monitoring your positions is important, especially to manage the risk of early assignment.
This strategy suits investors willing to sell shares at the strike price and those who prefer steady income over maximum growth. For active traders, integrating covered calls with other approaches can balance income and capital appreciation, unlike some daytrader strategies that focus solely on short-term price moves.
Final Words
Covered calls can enhance income on your stock holdings while limiting downside risk, but they also cap your upside if the stock rallies strongly. Review your portfolio to identify suitable shares and calculate potential premiums before implementing this strategy.
Frequently Asked Questions
A covered call is an options strategy where you own at least 100 shares of a stock and sell a call option on those shares. You collect a premium as income but agree to sell your shares at the option's strike price if the buyer exercises the option.
When you sell a covered call, you receive an upfront premium from the option buyer. This premium provides immediate income and can boost the overall yield on your stock holdings, especially in sideways or moderately bullish markets.
If the stock price exceeds the strike price at expiration, the option is likely exercised. You must sell your shares at the strike price, keeping the premium but missing out on any gains above that strike price, effectively capping your upside.
Covered calls offer limited downside protection because the premium you receive offsets some of the stock's losses. However, this cushion is partial and doesn’t fully protect you if the stock price drops significantly.
You need to own at least 100 shares of the underlying stock to sell one call option contract, as each option contract typically represents 100 shares.
The main risk is capped upside potential; if the stock price jumps sharply, you miss out on those gains above the strike price. Additionally, you still face potential losses if the stock price declines significantly.
Yes, covered calls are considered a relatively low-risk options strategy for beginners since you already own the stock, reducing the risk compared to naked calls. They can also enhance income from dividends in low-interest environments.
Absolutely. If the option expires worthless because the stock price stays below the strike price, you keep your shares and the premium, and you can sell another call option to continue generating income.
