1. What is a covered call?
A covered call is an options strategy in which you own shares of a company and sell a call option against those shares.
When you sell the call, you receive a premium. In exchange, you accept the obligation to sell your shares at the agreed strike price if the option is exercised and you are assigned.
For standard US equity options, one contract generally represents 100 shares. Therefore, owning 100 shares normally provides the coverage for one standard covered-call contract.
Within the Options Wheel, covered calls are commonly the second stage. You may reach this stage after being assigned shares from a cash-secured put.
Own 100 shares → sell one covered call → receive a premium → potentially sell your shares at the strike price if assigned.
2. How the trade works
Imagine you own 100 shares of a company currently trading at $50.
You decide to sell a call option with a $55 strike price and receive a premium of $1.00 per share.
Illustrative covered-call trade
| Trade detail | Example |
|---|---|
| Shares owned | 100 |
| Current share price | $50 |
| Call strike price | $55 |
| Expiration | 30 days |
| Premium received | $1.00 per share |
| Total premium | $100 |
You receive $100 in gross premium. In return, you accept the obligation to sell your 100 shares for $55 each if assigned.
What could happen?
- The share price stays below $55: The call may expire worthless. You keep your shares and the premium.
- The share price rises above $55: Your shares may be called away at $55. You receive the agreed sale price and retain the premium.
- The share price falls: You keep your shares and premium, but your underlying investment may lose value.
The premium provides a limited cushion against a fall in the share price. It does not remove the risk of owning the stock.
3. Choosing a strike price
The strike price determines the price at which you may be required to sell your shares.
Choosing a covered-call strike involves balancing the premium you receive against the possibility of your shares being called away.
Consider a stock trading at $50:
| Call strike | Position | General consideration |
|---|---|---|
| $50 | At the money | Typically higher premium, but shares may be called away more readily. |
| $52.50 | Out of the money | Potential balance between premium and retaining shares. |
| $55 | Further out of the money | More room for share-price appreciation, but typically lower premium. |
These are illustrative examples. Actual premiums depend on volatility, time to expiration, market conditions and the specific option contract.
Consider your original purchase price
If you acquired shares through assignment at an effective purchase price of $43.80, a $48 call may offer the possibility of selling above that price.
However, if the stock has fallen to $38, selling a call at $40 may create the possibility of being forced to sell below your effective purchase price.
Your strike selection should consider both your investment outlook and the financial result if your shares are called away.
A high premium may come with a greater chance of losing your shares at a price you would not otherwise choose to accept. Think about the share sale price before entering the call.
4. Understanding call delta
Delta measures the estimated change in an option's price for a $1 move in the underlying stock, all else being equal.
Call delta is generally positive. Traders also use it as a rough market-implied indicator of the likelihood of an option finishing in the money at expiration.
| Call delta | Illustrative interpretation |
|---|---|
| 0.10 | Lower absolute delta; generally a more distant out-of-the-money strike. |
| 0.20 | Moderate delta; often considered by traders seeking a balance between premium and retaining shares. |
| 0.30 | Higher delta; generally closer to the current share price and with greater exposure to assignment. |
| 0.50 | Often around at the money. |
Delta is not a guarantee of whether shares will be called away. It changes as the share price, implied volatility and time to expiration change.
You own 100 shares trading at $50. You compare several covered calls and find one with a 0.20 delta. This may be a useful candidate for further research, but you still need to decide whether the strike and premium make sense for your position.
5. Choosing an expiration date
The expiration date determines how long your shares are subject to the call obligation.
Shorter-dated calls
- Can provide more frequent opportunities to sell new calls.
- May require more frequent monitoring.
- Can become sensitive to share-price movements close to expiration.
- May offer less premium in absolute terms.
Longer-dated calls
- May provide a larger upfront premium.
- Keep your shares committed for a longer period.
- Can limit your flexibility if the stock rises sharply.
- Expose the position to more company news and market events.
Some traders examine expirations around 30 to 45 days, while others prefer shorter or longer periods. The right choice depends on the stock, market conditions and your objectives.
Consider upcoming events
Check earnings announcements, dividend dates and other corporate events before selling a call.
Dividend dates deserve particular attention with American-style equity options. Calls that are in the money and have little remaining time value can carry an increased risk of early exercise around an ex-dividend date.
6. Assessing covered-call premiums
The premium is the amount you receive for selling the call. In standard US equity options, a quoted premium of $0.80 generally represents $80 for one 100-share contract.
Premium as a percentage of share value
Illustrative calculation
| Value of 100 shares at $50 | $5,000 |
| Call premium received | $80 |
| Premium relative to share value | 1.6% |
$80 ÷ $5,000 × 100 = 1.6% for the life of the example trade.
This is a premium-to-share-value calculation, not a guaranteed investment return. It excludes share-price changes, fees, taxes and the possibility that your shares may be called away.
Implied volatility
Implied volatility reflects the market's pricing of potential future share-price movement. Higher implied volatility often produces larger option premiums, but it may also indicate greater uncertainty.
Liquidity and execution
- Check the bid and ask prices.
- Look at the bid-ask spread.
- Review trading volume and open interest.
- Consider using limit orders rather than automatically accepting the displayed bid.
A large displayed premium is not necessarily achievable at a sensible execution price.
7. When shares are called away
If your covered call is exercised and you are assigned, you are required to sell your shares at the strike price.
For example, if you own 100 shares and have sold a $55 call, assignment means selling those shares for $5,500.
Illustrative outcome
| Item | Amount |
|---|---|
| Original share purchase price | $50 |
| Call strike | $55 |
| Premium received | $100 |
| Share-price gain | $500 |
| Combined gross result | $600 |
The example assumes the shares are purchased at $50 and sold at $55, with a $100 call premium received. Fees, taxes and other costs are excluded.
Once the shares have been called away, you no longer own them. You can reassess the company and decide whether selling another cash-secured put is appropriate.
Remember that the share sale price is fixed by the strike if you are assigned. If the stock rises to $65, you still generally sell at $55 under the contract, giving up the additional upside.
8. Selling covered calls below your cost basis
This is one of the more challenging situations in the Wheel.
Imagine you were assigned 100 shares at an effective purchase price of $43.80. The stock subsequently falls to $35.
You still own the shares, but selling calls at or above $43.80 may offer relatively small premiums.
What are your choices?
Choice one: Sell a call above your cost basis.
You may receive a smaller premium, but you avoid agreeing to sell below your original effective purchase price, ignoring fees and other adjustments.
Choice two: Sell a call below your cost basis.
This may generate a larger premium, but if the stock rises through the strike and you are assigned, you could sell the shares at a loss overall.
Choice three: Hold the shares without selling a call.
You retain full upside participation if the stock recovers, but receive no call premium and remain exposed to further share-price declines.
Choice four: Sell the shares and reassess.
Closing the position may crystallise a loss, but it can release capital and prevent further exposure to a company you no longer want to own.
Your original purchase price is important for understanding your result, but it should not be the only factor in deciding what to do next. Reassess the company's current value, outlook and risks.
9. Managing difficult covered-call positions
When the share price rises towards your strike
You can allow the call to continue, buy it back to close, or consider rolling it to another expiration and potentially a higher strike.
Rolling up and out may give the shares more room to appreciate, but it may require paying a debit or accepting a different trade-off. Do not assume a roll will always be available for a credit.
When the share price falls
The call may lose value, but the underlying shares can lose considerably more. You could buy back the call, allow it to expire, or consider a new call after reassessing the stock.
Rolling a covered call
A roll involves buying back the existing call and selling a replacement call.
For example, you may buy back a $50 call and sell a later-dated $52.50 call. This changes the time and strike of your obligation.
Compare the total cost, new premium, additional time exposure and potential share-sale price. A net credit does not automatically make the combined position profitable.
10. Risks and common mistakes
1. Believing the premium protects the shares
The premium provides only a limited cushion. If the underlying stock falls sharply, losses on the shares can be much larger.
2. Selling calls too close to the current share price
This can increase the likelihood of your shares being called away, potentially earlier than you intended.
3. Ignoring the upside you give away
A covered call limits your upside above the strike if assigned. A sharp rally can leave you wishing you had not sold the call.
4. Selling calls below your cost basis without understanding the outcome
A premium does not necessarily offset the loss if you have to sell shares below their effective purchase price.
5. Ignoring early assignment
American-style equity options can be exercised before expiration. Understand the risks around dividends and in-the-money options.
6. Overlooking concentration risk
Owning several stocks in similar industries can create correlated exposure. Covered calls do not remove that risk.
11. Covered-call pre-trade checklist
- Do I currently own enough shares to cover the contract?
- Am I comfortable selling these shares at the selected strike?
- Have I considered my effective purchase price?
- Does the strike reflect my current view of the company?
- Have I considered delta and the likelihood of assignment?
- Have I checked the expiration date and earnings calendar?
- Have I considered dividend dates and early assignment?
- Is the premium worthwhile relative to the obligation?
- Are the option's bid-ask spread and liquidity acceptable?
- Do I have a plan if the stock rises sharply or falls significantly?
A covered call can generate premium from shares you already own, but it is not free income. You exchange some potential upside for the premium received while continuing to carry the downside risk of owning the shares.
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You now understand the two main building blocks of the Wheel: cash-secured puts and covered calls.
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