Question 1

What is a covered call strategy and how does it work?

Accepted Answer

A covered call is an options trading strategy where you sell call options against stock you already own. You collect premium income upfront, but cap your potential upside if the stock rises above the strike price. If the stock stays below the strike, you keep the premium and your stock. If it rises above, you may be obligated to sell at the strike price.

Question 2

When should I use covered calls?

Accepted Answer

Covered calls work best in sideways or slightly bullish markets where you expect modest stock appreciation. They're ideal when you want to generate income from stocks you plan to hold long-term, or when you're willing to sell at a predetermined price. Avoid them in strongly bullish markets where you'd miss significant upside.

Question 3

What are the main risks of covered calls?

Accepted Answer

The primary risk is opportunity cost - if your stock surges significantly, you're limited to the strike price plus premium. You also face unlimited downside risk if the stock falls (though premium income provides some cushion). Additionally, you may be assigned early if the option is deep in-the-money, forcing you to sell before expiration.

Question 4

How do I choose the right strike price?

Accepted Answer

Choose strike prices based on your profit goals and risk tolerance. Out-of-the-money strikes (above current price) offer higher premium but lower assignment probability. At-the-money strikes provide balanced premium and moderate assignment risk. In-the-money strikes offer lower premium but higher assignment probability. Consider your target selling price.

Question 5

What is the break-even price and why is it important?

Accepted Answer

The break-even price is the stock price where your total profit equals zero. It's calculated as: Current Stock Price - (Premium Received ÷ Shares). This is crucial because it shows how much the stock can fall before you start losing money. The lower the break-even, the more downside protection you have.

Question 6

How does time decay affect covered call profits?

Accepted Answer

Time decay (theta) works in your favor as a covered call seller. As expiration approaches, option premiums decrease, making it less likely for options to be exercised. However, this also means you should close positions early if you want to capture most of the time value. Longer-dated options offer higher premiums but tie up capital longer.

Question 7

What happens if my covered call gets assigned early?

Accepted Answer

Early assignment typically occurs when the option is deep in-the-money or near ex-dividend dates. If assigned, you must sell your stock at the strike price, potentially missing further upside. You'll receive the strike price × shares + any remaining premium. Early assignment is more common with American-style options than European-style.

Question 8

How do dividends affect covered call strategies?

Accepted Answer

Dividends can trigger early assignment, especially if the dividend amount exceeds the remaining time value of the option. Call buyers may exercise early to capture the dividend. To avoid this, consider closing positions before ex-dividend dates or using higher strike prices. Dividend income adds to your total return but doesn't affect the option's intrinsic value.

Covered Call Calculator

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The Covered Call Strategy Framework

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