There are many ways to make money with options, but perhaps the easiest and most effective is by selling covered calls for income. Not only does this strategy allow you to earn premium income, but you still benefit from marginal stock price increases.

That being said, learning how to sell options through a covered call strategy can also be complex. There’s a balance between configuring strike prices and expiration dates in your favor and still earning ample premium. You also need to understand how to find stocks for options trading.

We’ll cover all this and more below to set you up for success writing covered calls for income. Leveraging the VectorVest stock software with the OptionsPro integration is your best bet.

This dynamic duo allows you to effortlessly find opportunities and pick the perfect strike price and expiration dates that maximize returns while minimizing risk of exercise. Find out firsthand why it’s the best stock analysis app today!

What is a Covered Call?

Let’s start with the basics – what are covered calls? This approach to options trading combines holding a long position in a stock with writing (selling) call options on that same stock.

It’s commonly used by investors looking to generate additional income from their existing stock holdings for which they have a moderately bullish or even flat outlook.

So, you’ll need an understanding of the difference between a call vs put option and how stock options work in the first place. A call option gives the holder the right, but not the obligation, to purchase the stock at a predetermined price (the strike price) before a specified expiration date.

By selling the call options, you earn a premium from the buyer of the option. This acts as immediate income and provides a buffer against potential depreciation in the stock price. But what happens when options expire? There are two possible outcomes:

  1. Stock Price Remains Below Strike Price: If the stock price stays below the strike price, the option expires worthless, and the investor keeps both the stock and the premium.
  2. Stock Price Exceeds Strike Price: If the stock price rises above the strike price, the buyer exercises the option. You’re then obligated to sell the stock at the strike price, potentially missing out on further gains but still profiting from the premium and the stock appreciation up to the strike price.

You may be starting to see some of the benefits of trading stock options through a covered call method already. But, let’s take a closer look at an example of the covered call strategy for income below.

What is an Example of a Covered Call Strategy for Income?

The covered call income strategy can be a bit complex at first, so let’s use an example to simplify things for you. Say you own 100 shares of XYZ Corporation, currently trading at $50 per share. You’ve conducted some form of stock analysis and don’t see the price moving much in the short term.

So, you decide to sell a covered call option with a strike price of $55, expiring in one month. Selling the contract nets you a premium of $2 per share, amounting to $200 in total (options contracts are sold in lots of 100).

Now, it’s just a waiting game. If XYZ’s stock price remains below $55 by expiration, the option expires worthless. You keep the $200 premium, and your shares remain unchanged.

If it moves up a bit, say to $54, even better! You’ve earned a total of $600 from the sale ($4 price appreciation/per share plus the $2/per share premium).

But – what if the stock’s price does climb above the strike price, say, to $60 per share? As soon as it surpasses the strike price the contract is considered in the money (ITM). The investor who purchased the contract will exercise the option to buy the shares from you at a price of $55 each.

All is not lost – you’d still earn a solid return from the trade, this time, a profit of $700 ($5 price appreciation/per share plus the $2/per share premium).

HOWEVER – you forfeit the additional gains from the stock rising from $55 to $60. If you’d simply owned the shares outright you’d have earned a $1,000 return instead.

But as you’ll learn below, the covered call strategy for income is appealing because it protects you from downside potential. Because there is a third scenario we didn’t discuss – the stock’s price could drop, say, to $45/share.

The $200 premium you earned would provide a buffer from the $500 in losses from this dip in share price ($5/share loss across 100 shares). That being said, are covered calls good for income?

Are Covered Calls Good for Income?

There are pros and cons to any trading strategy, and covered calls are no exception. They can be a great way to earn income but there are trade-offs to be aware of too.

Regular Premium Income

Each time you write a call option, you collect a premium from the option buyer. This is yours to keep, regardless of whether the option is exercised or not. For investors seeking steady cash flow, especially in a low-interest-rate environment, this can be an attractive way to boost income.

Just how much premium you earn will depend on the stock itself, the strike price, and the expiration date you configure. There’s a balance between setting these in a manner that lowers the chance of the option being exercised and giving the buyer enough probability that they’re willing to pay you ample premium.

Downside Protection

While covered calls do not offer complete protection against a decline in the stock price, the premiums received provide a buffer. Even if the stock price drops, you can offset the loss to some degree through the premium earned.

This feature makes covered calls a somewhat conservative strategy compared to holding the stock outright, as it can reduce the overall volatility of the portfolio.

Enhanced Returns in Sideways Markets

The best scenario for selling covered calls for income tends to be in sideways markets when stock prices are stagnant. There is far less likelihood of the stock’s price exceeding the strike price in these conditions, so the contracts you’re writing will tend to expire worthless.

Potential Trade-Offs

You need to understand why covered calls are bad in some cases before using covered calls for income, too.

The biggest issue is that your profit potential is capped to the strike price should the stock’s price rally more than you’d anticipated. You’ll still benefit from capital gains up to the strike price, but the opportunity cost can be difficult to stomach in some cases.

There are tax implications at play as well. Should your options contract end up in the money (ITM) and the buyer chooses to exercise, you’ll have to sell them your shares. This can create a tax burden if you earned profit from the sale.

All things considered, though, yes – we believe covered calls can be a great income-generating strategy. You just need to set yourself up for success with education and the #1 investment app for beginner options traders. So, get started below!

Tips on Selling Covered Calls for Income

Successfully writing covered calls for income can be an easy, lucrative approach when you know what to look for in a stock and how to configure the contract in your favor.

We’ll cover all this along with the role of timing and proactive portfolio management below to help you execute this stock investment strategy.

What to Look for in a Stock

Choosing the right stock for covered calls can make or break your trades. The goal is to pick stocks with a consistent performance history, solid fundamentals, and high trading volume.

You want some level of volatility. You’ll have a hard time fetching attractive premium income if the stock’s price movement hasn’t budged much in weeks. Meanwhile, high liquidity ensures tight bid-ask spreads, making it easier to execute trades at favorable prices.

We suggest focusing your covered call strategy for income on dividend stocks as these are associated with well-established companies with steady earnings. These stocks are far more predictable. Here are some resources to point you in the right direction:

You can learn more about choosing stocks in our guide to the best stocks for covered calls 2024. But, using the best stock picker can make finding winning opportunities as seamless as possible.

Our stock advisory has a pre-curated list of stock screeners so you never have to look far for a stock that aligns with these principles above. This will create a solid foundation for your covered call income strategy.

Balancing Strike Price and Expiration Date With Premium Potential

We mentioned earlier there is a fine line between picking an expiration date and

strike price in options trading that earns you ample premium while giving you a buffer against volatility that prevents the option from being exercised.

You should pick a strike price high enough above the current stock price that allows for some capital appreciation while increasing the likelihood that the option will not be exercised. Be aware that the greater the gap between stock and strike prices, the less you’ll earn in premium.

Similarly, the expiration date should balance premium income with the time commitment. Shorter expirations (like weekly or monthly) offer higher annualized premiums and allow for more frequent adjustments. In contrast, longer expirations provide higher upfront premiums but lock your position for a longer period and increase the chance the contract will end up ITM at some point.

This is why risk management options trading is such an important concept, as is having the OptionsPro integration we’ve referenced a few times in this guide. It can help you pick the perfect “sweet spot”.

Timing Your Trades

Ideally, you should sell call options when the stock price is near resistance levels or when implied volatility is high, as this increases the premium received. Earnings reports, product launches, and other events can also cause sudden price movements.

Aligning your covered call writing with these factors helps you maximize premium income and reduces the risk of the stock price exceeding the strike price significantly.

Managing Your Positions

Keep an eye on the stock’s price movements and overall market conditions. If the stock price approaches the strike price, consider rolling the option

This is essentially closing the current position and opening a new one with a higher strike price or a later expiration date. You can capture more premium and continue to benefit from potential stock appreciation.

If the stock price drops a lot, it may make sense to buy back the call option at a lower price to close the position. This minimizes losses and frees up your capital for other opportunities.

Writing Covered Calls for Income Becomes Easier and More Profitable With VectorVest and OptionsPro!

We’ve said throughout this guide that using covered calls for income can be simple and effective when you have the right tools in your arsenal. VectorVest and OptionsPro is a dynamic duo for any options trader looking to boost returns and minimize their workload.

VectorVest is a proprietary stock rating system that takes complex technical and fundamental data and distills it into clear, actionable insights. You’re given all the information you need to make calculated, emotionless buy and sell decisions in 3 simple ratings, thereby winning more trades with less work.

But, the real magic for options traders comes with the integration of OptionsPro. This feature helps you navigate a list of stocks and identify those with the highest probability of delivering impressive profits. You can pinpoint the perfect window to sell and collect higher premiums.

It’s not just beneficial for those executing a covered call strategy for income generation – those interested in buying undervalued options contracts can leverage our software, too!

You gain access to tools like specialized theta decay charts, high-probability candlestick patterns, a proprietary Volatility Range Indicator, Probability Envelopes, and more.

With VectorVest and OptionsPro you’ll never have to wonder where your next opportunity will come from, and you’ll never worry about choosing the optimal strike prices or expiration dates again. See for yourself why it’s the best iPhone stock app and the best Android stock app today with a free stock analysis!

Final Thoughts on Using Covered Calls for Income

A covered call strategy for income can be an easy, effective approach to earning consistent returns without exposing yourself to additional downside. We hope you’re feeling confident and capable of writing covered calls for income after reading through this guide.

Remember to take your time to choose the right stocks and fine-tune the strike price and expiration date in your favor, while still balancing premium income potential. These elements of the covered call income strategy can be complex, which is why a solution like Vectorvest is so powerful.

Want to learn options trading more in-depth? We have additional resources on topics like options open interest, what does it mean to exercise stock options, warrants vs options, trading futures vs options, and building a stock portfolio in general.

Don’t leave any profit potential on the table or work harder than necessary. Set yourself up for a smooth, stress-free investment journey selling covered calls with VectorVest!