Covered Calls Explained: Generate Monthly Income from Stocks You Own

Covered Calls Explained: Generate Monthly Income from Stocks You Own

A covered call is one of the most popular income strategies in options trading — and one of the few options strategies where you are not exposed to unlimited downside risk.

How a Covered Call Works

You own 100 shares of a stock. You sell a call option against those shares at a strike price above the current price. In exchange, you collect the option premium immediately. If the stock stays below the strike price at expiration, the option expires worthless and you keep the premium. You can sell another call next month and repeat the process.

The Trade-Off

By selling the call, you cap your upside at the strike price. If the stock jumps from $50 to $70 and your strike was $55, you are obligated to sell at $55 — missing the $15 gain above the strike. You still profit (premium + $5 stock gain), just not as much as a pure stock holder.

Best and Worst Scenarios

The best scenario: the stock stays flat or rises slightly to just below the strike. You keep the full premium plus any stock appreciation up to the strike. The worst scenario: the stock crashes. The premium you collected provides only a small offset against a large loss in the shares themselves. Covered calls do not protect you from major downside in the underlying stock.

Selecting Strikes and Expiration

A common approach: use 30-45 days to expiration (DTE) and target a strike with a delta of 0.25-0.35. This gives you a good premium without giving up too much upside. Shorter expirations (7-14 DTE) generate premium faster but require more active management.

Tax Considerations

Each covered call premium is taxable as short-term ordinary income when the option is closed or expires. If the option is exercised and your shares are called away, the sale price of the shares (strike price) determines your capital gain or loss. Keep records — this strategy generates a lot of small taxable events.