Are you thinking of selling monthly covered calls for weekly or monthly income? If so, you came to the right place for this options trading strategy. Of course, if you landed here by accident, this article will blow your mind.
In my opinion, selling covered calls is one of the most conservative income trading strategies investors can use to generate additional weekly or monthly income on stocks they already own.
Indeed, I like to sell covered calls to generate portfolio income (option premium) – however, the key to being successful is to employ a high probability strategy. And, in this article, I’ll go through the process that I use, to sell covered calls, with the idea of keeping the entire premium.
What Are Covered Calls?
Before getting into selling covered calls, it’s important to know what an option is.
An option is a contract between two people, a buyer, and a seller. The call option gives the seller the obligation to do something should the buyer request it. Simple!
What Is A Call Option?
A call option is a contract where the buyer has a right (but not an obligation) to purchase an item (in this case, shares) at a set price, at any time before a specific expiration date. The seller has an obligation to sell the item if the buyer requests it (called exercising).
You may have heard about selling put options. Put options are the opposite of call options in that they allow the buyer the right (but not an obligation) to sell shares, at a set price, at any time before a specific expiration date.
For the purpose of this article, we’ll be talking about call options.
First, it’s essential to know what a call option is.
Read more: What is the best strategy for selling put options?
What Makes a Call Option “Covered”?
The “covered” portion of the covered call simply means that the call option seller already owns at least 100 shares of the underlying equity that he or she is selling the call option on.
How Does Selling Covered Calls Work?
For example, let’s take Jimmy, Sally, and a pound of beans.
Today, beans are worth $10 a pound.
Jimmy has 100 pounds of beans and wants to sell someone an option to purchase his 100 pounds of beans, in one month, for $11 a pound. You see, Jimmy thinks the price of beans will be about the same or lower (next month) than they are today.
On the other hand, Sally thinks the price of a pound of beans will likely go up next month.
So, Sally enters into an agreement with Jimmy to buy his beans at any time, up to a month from now, for $11 a pound. In return, Sally pays Jimmy a fee of $1 a pound for this contract (this is the covered call). The $100 is the income (option premium) that Jimmy gets to keep, no matter how much the beans go up or down in value.
Jimmy collects the $100 and agrees to sell Sally his beans next month for $11 a pound, should she decide.
Related read: Webull vs Robinhood – What to Know about These Two Brokerages
One month goes by…
Fast forward next month, if a pound beans cost more than $11, Sally will buy the beans from Jimmy for $11. Otherwise, if the beans cost less than $11, her option contract is worthless. Whatever happens, Jimmy gets to keep his $100 income (option premium) from Sally.
Who would you rather be? Jimmy, or Sally?
All options have rights and obligations. For example, those who buy call options have the right to buy the underlying equity from the seller at any point before the expiration date. In exchange, the option buyer pays the seller an option premium (income). And, this premium is a guaranteed income that you get to keep. Best yet, you can repeat the trade, again and again, week after week, month after month.
Things to Know About Selling Covered Calls
Like any investment, you’ll need to know some basic things about the trade. To be sure, selling covered calls requires a certain amount of understanding of the rights and obligations of both parties.
What do I need to Sell a Covered Call
To sell a covered call, you first need to own the (underlying) equity. And, considering each call option contract is for 100 shares of the underlying equity, you’ll need 100 shares x the number of call option contracts you wish to sell.
Suppose you want to invest 100k. You could start by buying the SPY. If you want to sell 1 covered call option on the SPY, you’ll need to have 100 shares of the SPY in your brokerage account. Conversely, if you want to sell 5 covered call options (and earn 5x the premium), you’ll need to have 500 shares of the SPY in your brokerage account.
What if I don’t have the equities in my brokerage account?
Naked call option selling is when you sell a covered call, but don’t have or want to own the underlying security. And, naked call options theoretically has unlimited risk. To be sure, it’s beyond the scope of this article.
Covered Call Lingo
When reading about, or discussing covered calls, it’s important to know what it all means – especially when it comes to generating income!
Strike Price
The strike price is the contracted price that the buyer can buy the equity from you (stock, or ETF). In the Jimmy and Sally example, $10 is the strike price.
Expiration Date
The expiration date is the last date the buyer can purchase the equity (called exercising) from you.
Options Premium (Your Income)
The option premium is the amount of money you get to collect for selling the covered call.
Related read: 19 Blue Chip Stocks for Incredibly Reliable Dividends
How much can you make selling covered calls?
In general, investors can earn anywhere between 1 and 5% (or more) selling covered calls. How much you earn depends on how volatile the stock market currently is, the strike price, and the expiration date. In general, the more volatile the markets are, the higher the monthly income you’ll earn from selling covered calls. Conversely, when the markets are calmer, you’ll have to sell calls with a further expiration date.
I prefer to sell “out of the money” covered calls with an expiration of about 3-6 weeks out. Indeed, this strategy gives me the most amount of income upfront. However, it limits the potential growth of the underlying equity. And, I’m OKAY with that!
Can I Become A Covered Call Millionaire?
Selling covered calls is a low-risk strategy for earning weekly or monthly income. Generally speaking, low-risk strategies on their own, won’t make you a millionaire. If you’re looking to become a millionaire, you might first look at how to become financially independent.
What Are The Risks in Selling Covered Calls?
The only risk in selling covered calls is that you may lose out on potential profit.
For example, let’s say you bought the SPY at $416.58 and sold an at-the-money-covered call with a strike of $417. Doing so netted a premium of $3.08 (or $308).
Then, at expiration, the SPY trades at $419. In this case, you’ll have lost out on $2 of profit. But, don’t forget, you’ll already have collected $3.08 (times 100) for the call option itself!
Getting called isn’t necessarily a bad thing. What’s important is that in the end, you’ll have made a profit.
Tax risk
If you have owned the underlying stock for a long time, you might have a significant capital gain, and if your option is exercised, that gain will be crystallized. Is it a big deal?
Suppose you’ve owned Abbot Labs since 2016 when it was trading around $40. If you had to sell your stocks in Sep 2024, you’d potentially have thousands of dollars of capital gains to deal with at tax time, for each call option contract sold. And depending on your tax rate, this could result in a significant tax burden.
For that reason, always keep a tax preparer on speed dial.
Examples of Selling Covered Calls
Let’s consider an example of selling covered calls to generate some income.
Suppose that as of today, September 16, 2024, the SPY is trading at $416.58. The $417 call option expiring October 16 is currently being bought for $4.08.
What does this mean? If you own 100 shares of SPY, you can sell 1 covered call option, and generate $408 in income, that’s yours to keep no matter what happens to the price of the SPY! Best yet, with selling covered calls, if you want more guaranteed income, you can sell more than one contract.
Related read: Stocks Vs. Options – What’s Right for You?
Selling Covered Calls: Scenario #1
Suppose today, September 16, 2024, the SPY Trades at $416.58
You buy 100 shares of the SPY for a total outlay of $41658.00
Then, you sell 1 covered call contract, out of the money ($417 strike) that expires October 16, for $408
Right off the bat, you’ve earned $408 from the covered call. Indeed, that’s covered call income you get to keep.
On October 16, if the SPY trades at $419, your contract will be exercised. Yes, you’ll have to sell your shares for $417. Is this bad? Well, consider that you bought the SPY for $416.58, and you sell it for $417 and collect another $408 in income. So, you’ve lost out on some upside, but the income (option premium) is yours to keep!
Crunching the numbers
However, consider that the SPY is above $417 on October 16, and you sold your SPY equity for $417. In this case, you’ll have a profit of $32 ( $417 – $416.68 = $0.42 times 100) on the SPY, and you still keep your $408, for a total profit of $440. Indeed, that a significant rate of return in just two weeks! How cool is that?
Selling Covered Calls: Scenario #2
Using the same SPY from scenario #1, you buy 100 shares of the SPY for a total outlay of $41658.00
Then, you sell 1 covered call contract, out of the money ($417 strike) that expires October 16, for $408
And like before, you’ve earned $408 from the covered call. Indeed, that’s the covered call income you get to keep. Also, don’t forget, it lowers your cost to buy the SPY by $408.
Then, on October 16, if the SPY trades lower, at $415. Note that this is lower than the strike price on your covered call. Also, it’s lower than what you paid for the SPY. Your call option contract expires worthless, and you get to keep your shares.
In this case, you get to keep your SPY, and the covered call expires worthless.
Crunching the numbers
You initially bought 100 of the SPY for -$41658.00
You received $408 in call option income (AKA Premium)
The value of the SPY shares on October 16, is now $41500.00
Your annualized rate of return is now 15.463%. Considering over the past 90 years, the annualized rate of return of the S&P 500 is 9.8%. So, I think 15.463% is a winner!
But, here’s where it gets interesting. In this case, your call option expired worthless, and let’s assume that you kept the shares in this scenario. Then, you can start selling another weekly or monthly call option, and that income is also yours to keep. Rinse and repeat!
How to Find Covered Calls Worth Selling
The goal of every call option seller is to let the option expire worthless. If you’re looking for the best chances of having an option expire worthless, I use an options scanner to scan the marketplace for different options. Let’s take Abbot Labs as an example. To scan for options, I can open my Options Samurai account, and start by clicking “compose new scan”.
Then, I’ll input in the stock, ABT, remove the option volume, remove expiration, remove moneyness, remove return – but I’ll keep annualized return, add open interest, and set the probability of expiring worthless to 90%. This means any call options that come up in the results will have at least a 90% chance of expiring worthless. Then, I hit “run scan” to see the results.
And in the above example, you can see the Abbot Labs $123 strike is selling for around $.16 or 16 per contract expiring Oct 2 – in just 2 days. The annualized return is 14.44% and there’s open interest, meaning there are currently people with orders ready to buy this option at this price. And best of all, there’s a more than 90% chance the option will expire worthless. Not bad!
How Do We Price Call Options?
Invessotrs price call options are on their intrinsic value (The difference between the strike price and the underlying equity), and time value – which is the rest of the value. Both “time to expiry” and “volatility” influence the time value heavily. Putting it differently, Investors will make the most money selling call options on dividend stocks with longer expiration dates, when volatility is high. If volatility is low, and the expiration is sooner, the option premium will be less.
Can I Sell Covered Calls on Dividend Stocks
Dividend stocks are shares in companies that pay a dividend. Many companies pay dividends, such as blue chip stocks on the coveted dividend aristocrats and the dividend kings lists.
Generally, copmany pay dividends from their net profits, but, it’s more of a best practice than a rule. Also, companies often pay dividends quarterly. However, some dividend companies also pay monthly, semi-annually, or annually. The dividend amounts are often the same, or greater each period. However, when times are tough, companies will often cut their dividend. The nice thing about selling covered calls is that no matter what happens to the dividend, you’ll still be able to sell the option.
When Selling covered calls, who keeps the dividend?
Now, you might be wondering about the dividend. First, if the company pays a dividend, the option will already factor it in to the price. Suppose we take Abbot Labs again as an example. Say you sell a covered call option on it. And, a dividend gets paid between now and the options’ expiration. The dividend amount will already be part of the option price when you sell it. So you get to keep the dividend AND the call option – and many investors make two even three or more times their income by using this strategy. Double-dipping is the colloquial term.
Is selling covered calls profitable?
Selling covered calls is a guaranteed way to earn weekly monthly income, and yes, it can be very profitable. The key is to remember to buy high-quality equities or ETFs. My favorite equities for selling covered calls on are the SPY (SPDR S&P500 ETF), and large, quality companies such as Apple and Google. Indeed, over the long term, these are high-quality companies whose stock prices generally move upwards.
However, you should have a plan B in case your equity loses value. In the SPY scenario above, if it dropped to $410 or $400 at the time of expiration, what could you do? Well, you could write another call option. Or, buy more of the SPY to lower your average cost and write more options, or you could take the loss (never fun) and move on to something else.
Can You Lose Money Selling Covered Calls?
You will never lose money by collecting the income from selling the covered call. To be sure, the income you receive from selling covered calls is yours to keep. However, if the equity loses value (i.e., the SPY drops below the purchase price), AND you sell it at a loss, then yes, that could incur a loss. So, just like having a home budget where you track your income and expenses, keeping track of your profit and loss on your covered call strategy is essential.
Calculating the returns
If you’re a numbers guy, like I am, you’ll probably want to calculate your annual rate of returns on covered call selling. So, here’s how you do it.
There are two returns you’ll probably want to know. The first is the total return. And the other is the annualized return. The total return is the amount of the income, divided by the stock price. Let’s say you got 72 cents for selling the call option on ABBT (Trading at $118), and the option expired worthless, your total return is around 0.6%.
Now, 0.6% might not sound fun, but what if that was just after a week, or a month?
If you sell a call option that expires worthless in 15 days, the annualized return would be: (option income x 365 days x 100) / (stock price x weeks left for call option expiration)
(.72* 365 * 100) / (118.00 * 15) = 14.85%
14.85% is far more interesting than 0.6%, isn’t it?
Bonus: What is a poor man’s covered call?
You may like the idea of selling covered calls, but don’t have or want to buy 100 shares of the stock or ETF. If so, consider the Poor Man’s Covered Call. To be sure, it’s also known as a credit spread or a covered call spread.
A poor man’s covered call has two variations. As above, when you sell a covered call, the call option is covered by the underlying stocks and ETFs that you already own. With a poor man’s covered call, you don’t actually need to own the stock! Rather, you’ll need to replace the stock with something else. Here are the two variations:
A variation on a Poor Man’s Covered Call #1: The Vertical Spread
With a vertical spread, you sell a slightly out of the money call option, and then buy a further out of the money call option.
Suppose we borrow from the same example as above, today, the SPY is trading at $416.58.
The October 16 $417 call option is selling for $4.08.
The October 16 $420 call option is selling for $3.50
In this case, if you don’t own or want to own $41,658 ($416.58 * 100) of the SPY, then you could sell the October 16 $417 SPY call option for a total of $408. And, at the same time, you can buy the $420 call for $350, leaving you $58. The call option that you bought becomes the covered portion.
WARNING: There is a risk with a this scenario. The risk is if the SPY trades above $417, you’ll have to sell 100 shares of the SPY at $417. However, your risk is limited. It is the difference between the option strike you sold, and the option you bought, minus the premium received.
So in this case, the risk is $242 and we calculate it as follows: (($420 – $417) – $0.58 ) * 100 = $242 . As a result, you’ll want to consider selling this type of strategy further out of the money to avoid surprises.
Variation #2: Using Leaps In a Covered Call Strategy
With variation #2, you can sell a poor man’s covered call by buying an in the money LEAPS option, as far out as possible. A LEAPS option is like a traditional option, only that it has a much longer expiration. At the time of this writing, LEAPS on the SPY go as far out as two and a half years.
If we borrow from the same example as above, today, the SPY is trading at $416.58.
The SPY October 16 $417 call option is selling for $4.08.
The SPY October 16, 2024 $290 call option is selling for $152.49
In this example, you can buy the SPY October 16, 2024 $290 option for $15,249. And you can hold it until expiration. We are buying the $290 because the further in the money it is, the higher the delta will be. In other words, it will be better correlated to the actual market prices.
Then, you can start selling covered calls (out of the money). If you get exercised, not to worry, your LEAPS option will have gone up (near) proportionately. If the SPY goes down, again, you keep the income from selling covered calls.
Frequently Asked Questions (FAQ)
The only thing that is bad about covered calls is that you lose any potential upside over and above the strike price. However, you do collect the income as a result.
A poor man’s covered call is also known as a credit spread. In this case, the “poor man” either doesn’t have the funds to purchase the 100 shares of the equity, or just doesn’t want to buy the equity. In this case, the “poor man” sells his covered call and then buys one at a strike price slightly further out of the money (for less than the call he sold). The “poor man” gets to keep the difference, known as the credit. The risk is the difference between the strike prices. A credit spread (or poor man’s covered call) is a riskier transaction but requires less money upfront, and one for another article.
Anyone seeking additional income from their portfolio should consider selling covered calls.
At a minimum, you will need a brokerage account, with options trading (You might need to let the brokerage know you want to sell covered calls).
As soon as you sell your covered call, the income (option premium)gets deposited into your brokerage account. Generally speaking, you can do whatever you want with it.
You can sell weekly covered calls, however, just be aware that you will collect more income, the further into the future you sell the call.
In my opinion, selling covered calls on high-quality stocks and index ETFs gives you the best consistent return.
Most agree that of all option strategies, selling covered calls is among the safest strategies out there. Selling covered calls is a safe strategy because you already own the equity, and the monthly income (premium) you earn lowers the actual cost of ownership.
The aim of this website isn’t to provide investment advice; instead, it gives you the tools and knowledge to become financially independent.
Traders who sell covered calls always get to keep the income. However, a loss can occur if the stocks, ETFs, or Futures contract is assigned at a loss.
Conclusion
Selling covered calls can be an excellent way to generate monthly income. To be sure, any investment incurs a little risk, and I feel that by selling a covered call, you are reducing your overall risk.
*Disclosure: On the date of publication, Rick Orford did not have (either directly or indirectly) any positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. The information herein is based solely on my personal opinion and experience. All investments hold inherent risk, and the information provided should not be interpreted as any kind of guidance, recommendation, offer, advice, or suggestion. Any ideas and strategies discussed on this channel should not be implemented without first considering your financial and personal circumstances or without consulting a financial professional.
I’m not very familiar with any of this and I have been reading your blog and it’s very thoroughly descriptive, which I appreciate. I am trying to take in as much info as I can before I make any moves.
Great article! Yeah, covered calls are really intereting way to make some profit in the market. Basically the best example for is when you sell a covered call, you get paid in exchange for giving up a portion of future upside. Simple
But I do prefer day trading futures, they are incredible goo for beginners and you can make a lot of profit. Futures are less volatile than forex but they’re still good for doing day rading
Thank you. I am transitioning out of my career. My goal is to live off monthly income from selling covered calls. Wish me luck!
I’m considering your path as well
You can sell weekly covered calls?