What is a Covered Call? (Generating Income From Stocks You Own)
The covered call is a popular income strategy that lets you "rent out" your stocks in exchange for cash premium.
Quick Summary
A Covered Call is when you own 100 shares of stock and sell a call option against them. You collect premium immediately in exchange for agreeing to potentially sell your shares at the strike price. It's one of the most conservative options strategies.
Most investors think there are only two ways to make money in the stock market:
Three Ways to Profit from Stocks
Method #1
Price Appreciation
Method #2
Dividends
Method #3
Covered Calls
The third way is to "rent out" your stocks to generate a stream of income. This strategy is called the Covered Call—one of the safest options strategies, often allowed even in retirement accounts (IRAs).
The Definition: What is a Covered Call?
THE STRATEGY
Own 100 shares + Sell 1 Call Option = Collect Cash Premium
"Covered"
You own the underlying shares. If the option buyer exercises, you already have the stock "covered" in your account. No need to buy it at a loss.
"Call"
You're selling someone else the right to buy your shares at a specific price (Strike) by a specific date (Expiration).
In exchange for giving someone this right, you get paid a cash premium immediately. This cash is yours to keep, no matter what happens.
How It Works: The "Landlord" Analogy
Think of your 100 shares of stock as a house.
- You own the house (your 100 shares)
- You hope the value goes up over time (appreciation)
- While you wait, you rent it out to collect monthly cash (the premium)
The catch? The tenant has a special clause: "If the house value hits a certain price (Strike Price), I can buy it from you."
A Real-World Example
Let's say you own 100 shares of Apple (AAPL), currently trading at $150. You want to generate extra income, so you sell a Covered Call.
Stock Price
$150
Strike Price
$160
Expiration
30 Days
Premium Received
$3.00 × 100 = $300
Day 1: You instantly collect $300 cash. Your effective cost basis drops to $147/share.
The Three Possible Outcomes
At expiration: AAPL is trading at $158
Price is below your $160 strike. The option expires worthless. You keep your 100 shares AND the $300 premium. You can now sell another covered call next month ("rinse and repeat").
At expiration: AAPL drops to $140
You still own the shares (now worth less), but the $300 premium acts as a cushion. You lost less money than a shareholder who didn't sell the call. Effective loss: $10/share minus $3 premium = $7/share net loss.
At expiration: AAPL shoots up to $170
Price is above your $160 strike. You are assigned—forced to sell at $160 even though shares are worth $170. You profit $10/share ($150→$160) + $3 premium = $13/share. But you missed the extra $10 gain from $160→$170.
Scenario C Profit Breakdown
You made money, but capped your upside
Missed potential: Additional $10 gain if you hadn't sold the call
When Should You Use This Strategy?
The Covered Call is a Neutral to Slightly Bullish strategy.
When to Use vs. Avoid
You think the stock will stay flat or go up slowly. You want to generate income while you wait. You're okay with potentially selling at the strike price.
You think the stock is about to "moon" (explode upwards). If it doubles in price, you'll be forced to sell early and miss massive gains.
Frequently Asked Questions
Summary
The Covered Call is the bread and butter of income investors. It transforms a stagnant portfolio into a cash-flow machine.
The "risk" is not losing money—it's limiting your upside. By accepting the premium today, you agree to cap your potential profit tomorrow. For many investors seeking steady returns, that's a trade-off worth making.
The Covered Call Trade-Off: Collect guaranteed cash now in exchange for potentially capping your gains if the stock moves significantly higher.
