When to use it?
You hold 100 shares of a stock and think it will stall or rise modestly over the coming weeks. You are seeking extra yield on your portfolio. You would be OK selling your shares at the strike (typically 5-10% above the price).
When to avoid it?
You are expecting a big bullish catalyst (very strong earnings, a likely buyout, etc.) — you would cap your gain. Also avoid on highly volatile names where the strike can be breached early and you miss a 30% rise for $200 of premium.
How it works
You OWN 100 shares. You sell 1 OTM call (strike above the current price). You collect the premium immediately.
At expiration:
• Stock BELOW the strike: the call expires OTM. You keep your 100 shares AND 100% of the premium. You can write another covered call next month.
• Stock ABOVE the strike: you are assigned. You sell your 100 shares at the strike (instead of the higher market price). You keep the premium. You miss the upside above the strike.
The "covered" comes from the fact that you CAN deliver the shares if exercised — unlike the naked short call.
Concrete example
You hold 100 shares of AAPL bought at $150. Current price: $175. You sell a call with strike 185, premium $3, 35 days to expiration.
Premium collected: $300.
At expiration:
• AAPL at $170 → call expires OTM. You keep the 100 shares (worth $17,000) + $300. ROI = 1.7% in 35 days on the $17,500 basis.
• AAPL at $180 → call expires OTM. You keep everything. Same as above.
• AAPL at $185 → call ATM. You keep everything (the limit).
• AAPL at $190 → assigned. You sell at $185. Realized gain = (185 − 150) × 100 + 300 = $3,800 (vs $4,000 without the call = $200 opportunity cost).
• AAPL at $220 → assigned. You sell at $185. Gain = $3,800 (vs $7,000 without the call = $3,200 opportunity cost).
That is the cost of the strategy: a cap on your gains beyond the strike.
The "wheel" — the complete strategy
The covered call is typically used together with the cash-secured put in a strategy called "the wheel":
1. You sell a cash-secured put on a stock you want to own.
2a. If not assigned → you collect the premium and start over.
2b. If assigned → you buy the 100 shares at the strike.
3. Once assigned, you sell a covered call on the shares.
4a. If not assigned → you collect the premium and write another covered call.
4b. If assigned → you sell your shares at the strike. Back to step 1.
Executed well on quality names (e.g. KO, JNJ, MSFT), this strategy can generate 10-20% per year of income — better than a dividend, with more risk but also more control.
Choosing the strike — rules of thumb
**Delta 0.20-0.30** (~85-95% probability of expiring OTM): a modest premium but a high probability of keeping the shares. Ideal for names you want to hold long-term.
**Delta 0.30-0.40** (~70-85% probability OTM): the best premium/probability trade-off. Standard for the wheel strategy.
**Delta 0.50+** (~50% probability OTM): a generous premium but frequent assignment. More turnover, so more fees and monitoring.
For **DTE** (days to expiration): the 30-45 day window offers the best theta decay (the premium's value melts fastest in that zone). Beyond 60 days, you receive too little premium for the risk.
⚠ AMF disclaimer
Options are high-risk derivative products. Losses can exceed the capital initially committed (particularly for uncovered short positions). Polaris provides educational content only — this is not investment advice. Consult a registered advisor (AMF) before any decision and make sure you have the appropriate level of approval from your broker.