Selling covered calls is a great way to earn income in a relatively stagnant market, capitalizing on open positions you already have without exposing yourself to many downsides.
But, figuring out how far out to sell covered calls is essential for earning a nice profit and getting to keep your shares. The expiration date you choose impacts not just your returns but also the likelihood of having your shares called away.
There are pros and cons to short and long-term expiration alike. At the end of the day, it’s just a matter of balancing your income goals with your risk tolerance in accordance with the market conditions. While selling weekly covered calls has its place, you might be better suited to monthly expiration dates, or even further out.
We’ll talk more about timing your trades below and how to set yourself up for success. VectorVest’s stocks software can be paired with OptionsPro to eliminate any guesswork with picking your expiration date, showing you where you’ll maximize premium.
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Why Sell Covered Calls?
You need to have an understanding of how stock options work and the difference between a call vs put before we go any further.
These are contracts that give the holder the right – but not the obligation – to buy/sell a stock at a predetermined price (the options strike price) before a predetermined date (expiration date).
A put option gives the holder the right to sell a stock at the strike price before expiration, while a call option gives the holder the right to buy a stock at the strike price before expiration. With that said, let’s get into the basics of covered calls.
What is a Covered Call?
So, what is a covered call? This involves selling a call option against a stock you already own – which is why it’s called “covered.” If the holder chooses to exercise their right to buy the shares from you, you already have them on hand ready to be transferred.
In exchange for this right, the buyer pays you in the form of premium. This is typically a few dollars per share, and it’s yours to keep regardless of the outcome of the contract.
The end goal is to end up earning that premium income without having to sell the holder your shares – which is why this stock investment strategy works best with stocks that are range bound and aren’t moving up or down too much.
Key Benefits of This Strategy
The benefits of trading stock options through a covered call strategy are clear – you can earn income through premium without taking on much risk, if any.
It’s especially attractive in sideways or slightly bullish markets, where stock price appreciation is limited. The premium acts as a cushion against minor declines in the stock price as well – so even if share prices fall slightly, you could still turn a profit overall.
What’s the Catch?
You need to understand why covered calls are bad in some cases, though. It all comes down to opportunity cost. If the stock price rises significantly above the strike price, you are obligated to sell your shares at the strike price, missing out on the upside.
Sure, you’ll still earn some profit from the increase in stock price up to the strike price – but you would earn more without the call option forcing you to sell at a lower price.
Let’s say you bought into Stock XYZ at $50/share and wrote a covered call with a strike price of $55/share. If the stock climbs to $58/share, the holder would more than likely exercise stock options and buy the shares from you at $55. You’d earn just $5/share rather than the $8/share.
Assignment – the act of having to sell your shares when the option is exercised – can also create issues with your stock portfolio building strategy as well.
Say you owned shares that paid dividends – you could miss out on being a shareholder of record on the ex-dividend date depending on when your shares are called away.
There are tax implications associated with forced sales as well. You could trigger capital gains taxes on covered calls without meaning to.
All things considered, though, you have more power than you realize to configure these contracts in a manner that reduces the risk of assignment. One of the best ways is to understand how far out to sell covered calls.
How Far Out to Sell Covered Calls
There’s a balance between setting expiration dates for covered calls far enough out to earn more premium and not setting them so far out that you’re exposing yourself to unnecessary risk. We’ll help you perfect the timing of your contracts below.
Short-Term vs Long-Term Expiration
A shorter-term expiration (like weekly or monthly options) will bring in lower premiums but allows you to write calls more frequently, potentially generating more consistent income. The trade-off is that you may need to monitor and manage your positions more frequently.
These shorter-term options also have less time to get “in the money” – which is the point at which the stock price exceeds the strike price and your shares will be called away.
On the other hand, longer-term expirations (several months out) can provide higher premiums upfront but tie up your shares for a more extended period. This approach can still make sense if you expect minimal stock price volatility or if you prefer a more hands-off strategy.
However, the downside is that your flexibility is reduced, and you might miss out on opportunities to sell more calls if the stock price remains stable. There is also more time for the contract to end up in the money, which is the worst-case scenario most of the time.
Premium Decay Over Time (Theta)
To effectively configure expiration dates in a manner that stacks the odds in your favor, it’s important to understand theta. This is the rate at which the value of an option decreases as it approaches its expiration date.
This decay accelerates as the expiration date nears, making short-term options more attractive for sellers looking to capitalize on rapid premium decay.
That being said, you can benefit from this faster decay if you sell covered calls with a shorter expiration. The option’s value decreases quickly, potentially allowing you to repurchase it at a lower price.
Market Conditions and Volatility Considerations
The market conditions and volatility should influence your decision as well. Premiums tend to be higher in a volatile market as these conditions are more favorable for options buyers. Thus, you can typically earn enough premium while shortening how far out you’re selling covered calls.
Conversely, longer-term expirations might be more appropriate in stable or slightly bullish markets when premiums tend to be lower.
Ultimately, only you can determine how far our to sell covered calls. It depends on your relationship with the stock in question, the market conditions, your risk/reward spread, and more.
Don’t Play the Guessing Game With Expiration Dates
Like we said from the start, OptionsPro gives you a myriad of tools to effortlessly choose an expiration date that maximizes premium while reducing the likelihood of assignment.
One of the tools is Probability Envelopes, which show you your odds at different strike prices and expirations dates so you can make more informed decisions. Or, use the Options Skew chart to compare multiple expiration dates and see which gives you the best opportunity.
You don’t have to play the guessing game when writing covered calls for income. Give yourself the best odds with a tried-and-true system that saves you time and stress.
Other Factors to Consider in Writing Covered Calls
We know you came here specifically to learn how far out to sell covered calls, but this is just one piece of the puzzle. You also need to think about the underlying stock itself and the strike price in relation to the expiration date you choose.
The Underlying Stock Itself
The best stocks to sell covered calls are those with some volatility, as this makes them more attractive from the seller’s perspective, but not enough that you’re going to deal with large price swings that could put your contract in the money.
Aside from stock volatility, think about the stock’s dividend yield, earnings reports, and overall market sentiment. A stock that’s well-regarded, with a strong track record of performance, may offer a better balance between risk and reward when writing covered calls.
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The Strike Price
Just like with the expiration date, the strike price can impact the profitability of your covered call strategy along with the odds you’ll be assigned.
The closer the strike price is to the stock price, the greater chance it has of ending up in the money and in turn being exercised. You’ll earn higher premium since you’re taking on more risk as a seller.
On the other hand, a call option with a strike price further from the stock price is less likely to end up being exercised – meaning you’ll earn lower premium, but won’t have to worry as much about having your shares called away.
There’s a balance to be struck here between profit potential and risk. The strike price should align with your market outlook as well.
Timing Your Trades
Timing is everything in the stock market, and writing covered calls is no different. Ideally, you want to write covered calls when the stock price is near resistance levels or when you expect the stock to trade sideways or slightly upwards.
Writing calls just before a company’s earnings report or ex-dividend date can be risky, as these events often trigger price movements. Stay abreast of market cycles, seasonal trends, and upcoming events related to the stock and choose the optimal time to write covered calls.
Parting Thoughts on How Far Out to Sell Covered Calls
Choosing how far out to sell covered calls requires a balance between earning ample premium and protecting against the risk of assignment.
Shorter-term options tend to offer quicker premium decay, allowing for more frequent opportunities to generate income. However, longer-term options can provide more substantial premiums, albeit with more extended exposure to market risk.
Only you can determine what makes the most sense for your specific risk tolerance, income goals, and market outlook when picking an expiration date for covered calls. But, you can rely on the Vectorvest and OptionsPro tandem to eliminate stress, uncertainty, and guesswork.
Looking for the best way to learn options trading? Our blog has more tips on how to make money trading options, including how to sell options, what happens when options expire, warrants vs options, open interest in options, options risk management, IV in options trading, trading futures vs options, covered call ETFs, long calls vs covered calls, and more.
If you’re just getting started trading stock options for beginners or are looking to boost your returns, remember that our investment app for beginners is just a few clicks away. It’s the best iPhone stock apps and the best Android stock apps alike.
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