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What are Covered Calls

To understand covered calls, we need to understand the concept of call options. A call option gives the buyer the right, but not the obligation to buy an asset, in this case, stocks. Also, an important concept is that most options are applicable to 100 shares, so one option is for 100 share of whatever stock you’re looking at. A tangible example would be, say you think Ford is trading at $9.50 a share. Due to whatever investor mojo you have you think or know that within the next six months, the shares will be $12.50. You’d really like to purchase the shares at the price of $9.50 but you don’t necessarily want to spend the money to buy 100 of them so instead you pay a small premium (something like $14). So now, for the cost of $14, I have the right to buy 100 shares at $9.50/share ($950). If the stock raises up to the predicted 12.50, I will have $3 * 100 in equity, or $300 in equity.

After factoring in the premium you’ve spent plus the initial $950 spent to buy the stocks you’re all in at $964, with the value of your shares being $1,250 that’s a 30% return. Let’s say it dropped to $5.25 instead, in this instance, you’d still retain your right to buy, but you have no obligation to buy 100 shares at $9.50 a share when it sits well below that. In this case, you only lost $14. Where had you bought 100 shares, you’d now be down $4.25/ share, a 45% loss.


That’s a call option, now let’s say instead of cash and speculating, you actually hold the 100 shares instead. This is the other side of the call option. If you have 100 shares, you can cover the call option. What does this mean?

Well, it means that you’re agreeing to sell your shares at a given price for a premium. So in the last example, you’d have 100 Ford shares, and you’d receive a premium of $14 for a call option that expires in 10 days. This means if the price goes above $9.50 in those ten days, the holder of the call option can buy your shares at any moment for the agreed price. If the price drops below the strike price of $9.50, then you keep the premium and stocks.

There are a few strategies one can employ to grow their holdings or earn income from existing assets. One method is to buy 100 shares at a given price as it’s rising and immediately setting a covered call for $1-$2 more per share than they bought it for a significant premium. The idea here is you are expecting to let the stock go before the end of the contract, but at a price higher than what you bought it plus the premium.

Another strategy is very similar, but instead of buying a fast rising stock (which seems risky, not something I do) they buy decent companies around their 52 week low and covered call them every week or other week. The expectation here is not to lose the stock but to generate a steady weekly or biweekly payment from your assets. Whether you live off of those or reinvest is up to you.

Lastly, this can be a way to get rid of your stocks and get paid to do so, it is a nice way to offload 100 share portions at a time and receive income from it.