Covered Calls: get paid extra on the shares you already own
How investors use covered calls to complement long-term portfolio management
A covered call is an options strategy investors use to make extra income on shares they already own. This article covers how the strategy works, when investors use it, and what happens after you place the trade.
What is a covered call?
A covered call is a type of option trade, often used as an income generating companion strategy to long-term portfolio management. Investors use it to earn extra cash on shares they own while generally exposing them to the same downside risk as just holding the shares.
When investors use covered calls
Covered calls are often used on holdings investors plan to keep in a steady or slow market, where they collect income while they hold. The trade-off: the upside is capped at the strike price they set.
The strategy can also be used on positions already at a loss, where the premium offset part of the decline.
However, a covered call is not downside protection. The shares are committed for the life of the contract or until the contract is bought to close, so if the stock falls, investors lose what they would have lost anyway, minus the premium.
Before you start
You’ll need at least 100 shares of the desired stock or ETF in one account. Each option contract covers exactly 100 shares.
Your account needs options trading enabled. You can check this in your web portal under “Management” > Options Level.
Trading covered calls in your platform
You can view your holdings under your “Positions” tab. On the Questrade app, trade options by tapping on your position and hitting “Trade” > “Trade Options”.
Placing your order
When you sell a covered call you’ll pick four items:
The holdings you’ll sell on: this is called the underlying. Pick a holding you have at least 100 shares of, and that you don’t think will rise significantly before your expiry.
The price you would sell at: this is your strike price. Pick a price you would be content selling your shares at. A higher strike pays a smaller premium and leaves you more room to gain. A lower strike pays a larger premium and is more likely to sell your shares.
Your expiration date: Your expiration. This sets how long your shares stay committed. A shorter date pays less premium and releases your shares sooner. A longer date pays more and holds the obligation longer.
The number of contracts: One contract per 100 shares you want to commit. You can cover part of your position and leave the rest free.
Once placed, it goes to market. When your option finds a buyer, your order fills, and the premium is credited to your account. The position appears under Positions then Options.
The premium quoted before you place the order is an estimate. It moves with the market until your order fills. For current commissions and fees, see the Questrade pricing page.
Note: Shares backing an open contract are committed until the contract closes or expires. You cannot sell them in the meantime.
What happens next
There are two possible outcomes:
Outcome 1: You keep your shares, and the premium.
This happens when the price of your underlying stock remains below your strike price until the contract expires.
Outcome 2: The shares are sold away at your strike price.
This happens when your underlying stock goes above your strike price and the shares are called away. You keep the premium, but the gains above your strike price go to the buyer.
This typically happens when the contract expires, however, in some rare cases, the option buyer could exercise their option before the contract expiry. This is called early assignment.
Shares are usually sold away when the contract expires, however in some rare cases, the option buyer could exercise their option before the contract expiry. This is called early assignment.
An example
You own 100 shares of a stock trading at $325. You sell one call with a $340 strike, expiring in 30 days, at a premium of $1.80 per share.
Market Price | What happens | What you end up with |
Stock at $335 | The underlying remains below your strike price. | You keep your 100 shares, plus the $180 premium. |
Stock rises above $340 | Your shares can be sold away if the buyer exercises their right to buy the option. | Your shares are sold at $340. You have $34,000, plus the $180 premium. |
If the stock finished at $350, you would have made $2,500 by holding. Selling at the $340 strike plus the $180 premium returns $1,680.
Risk
All investing involves risk. A covered call is typically considered as a conservative options strategy because investors are paid a premium for the stocks they already own. The upside is capped, where above the strike price, the gains belong to the buyer.
Investors typically use covered calls when they:
Hold 100 or more shares they would be comfortable selling at the chosen strike price
Expect the stock to stay flat or rise modestly
Want income from an existing position
A covered call is less common among investors who:
Expect a large move up in the stock
Do not want to sell the shares at any price
Hold fewer than 100 shares
Note: In some cases, your shares can be sold before the expiration date through early assignment. In these situations, your downside is not the same as holding the stock outright.
