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Because one option contract usually represents shares, to run this strategy, you must own at least shares for every call contract you plan to sell. First, choose a stock in your portfolio that has already performed well, and which you are willing to sell if the call option is assigned.
Normally, the strike price you choose should be out-of-the-money. Next, pick an expiration date for the option contract. Consider days in the future as a starting point, but use your judgment. You want to look for a date that provides an acceptable premium for selling the call option at your chosen strike price.
Remember, with options, time is money. The further you go out in time, the more an option will be worth. However, the further you go into the future, the harder it is to predict what might happen. On the other hand, beware of receiving too much time value. Check for news in the marketplace that may affect the price of the stock, and remember if something seems too good to be true, it usually is.
A Guide to Covered Call Writing. Obviously, the bad news is that the value of the stock is down. The risk comes from owning the stock. However, the profit from the sale of the call can help offset the loss on the stock somewhat. Although losses will be accruing on the stock, the call option you sold will go down in value as well.
If your opinion on the stock has changed, you can simply close your position by buying back the call contract, and then dump the stock.
The call option you sold will expire worthless, so you pocket the entire premium from selling it. You made a conscious decision that you were willing to part with the stock at the strike price, and you achieved the maximum profit potential from the strategy. Pat yourself on the back. Many investors use a covered call as a first foray into option trading. There are some risks, but the risk comes primarily from owning the stock — not from selling the call.
The sale of the option only limits opportunity on the upside. Time decay is an important concept. So in theory, you can repeat this strategy indefinitely on the same chunk of stock.
You may also appear smarter to yourself when you look in the mirror. But we're not making any promises about that. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments.
Please consult a tax professional prior to implementing these strategies. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point.
The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. System response and access times may vary due to market conditions, system performance, and other factors.
Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results.
All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between. Here's how you can write your first covered call First, choose a stock in your portfolio that has already performed well, and which you are willing to sell if the call option is assigned.
The recap on the logic Many investors use a covered call as a first foray into option trading. Back to the top.