Selling Covered Calls

What is a Covered Call?

A covered call is when you sell a call option against shares you already own. It's "covered" because you have the shares to deliver if the option is exercised. This is the second phase of the wheel strategy.

How It Works

When you sell a call option, you're giving someone the right to buy your shares at the strike price. In exchange, you receive premium upfront.

Example:

• You own 100 shares of XYZ at $50
• You sell the $55 call for $1.50
• You collect $150 in premium
• If stock stays below $55: keep shares + premium
• If stock rises above $55: sell shares at $55 + keep premium

Three Possible Outcomes

1. Stock Stays Below Strike (Most Common)

• Option expires worthless
• You keep the $150 premium and your shares
• Repeat the process with another call

2. Stock Rises Above Strike

• Shares get called away at $55
• You keep the $150 premium
• Total gain: $55 - $50 (stock gain) + $1.50 (premium) = $6.50/share
• Back to cash, ready to sell puts again

3. Stock Falls

• Option expires worthless (you keep premium)
• Shares are worth less, but premium cushions the loss
• Consider selling another call or waiting for recovery

Strike Selection for Calls

Call strike selection is about balancing income vs. growth potential:

Delta	Probability Called	Premium	Upside Cap
0.40	~40%	Highest	Limited
0.30	~30%	Good	Moderate
0.20	~20%	Medium	More upside
0.10	~10%	Low	Most upside

The Cost Basis Strategy

Your goal should be to lower your cost basis over time:

Starting position: Bought at $50

Month 1: Sell $55 call, collect $1.50 → Cost basis: $48.50 Month 2: Sell $55 call, collect $1.30 → Cost basis: $47.20 Month 3: Sell $55 call, collect $1.40 → Cost basis: $45.80

After 3 months, even if the stock is flat, you've reduced your effective purchase price by $4.20/share (8.4%).

Above vs. Below Cost Basis

A key decision: sell calls above or below your purchase price?

Above Cost Basis (Safer):

• If called away, you profit
• Lower premium but no loss risk
• Best for stocks you expect to rise

At or Below Cost Basis (More Income):

• Higher premium
• Risk selling at a loss if called
• Best for reducing cost basis on losing positions

Timing Your Calls

Best time to sell covered calls:

Situation	Action
Stock rallies after put assignment	Sell call at higher strike
High IV environment	Premiums are elevated
30-45 DTE	Optimal theta decay
Above resistance level	Less likely to be called

Avoid selling calls:

Situation	Why
Before positive catalyst	Miss potential upside
At 52-week lows	Could rally sharply
Very low IV	Premium not worth it

Rolling Covered Calls

If the stock approaches your strike, you have options:

1. Let it get called - exit the position with profit
2. Roll up and out - buy back call, sell higher strike further out
3. Roll out - same strike, later expiration, collect more premium

Dividends and Covered Calls

If the stock pays dividends:

• Ex-dividend date matters for call assignments
• ITM calls may be exercised early before dividend
• Factor dividend into your total return calculation

Calculate Your Total Return

Component	Example
Call premium	$1.50
Stock appreciation (if called)	$5.00
Dividend (if any)	$0.50
Total per share	$7.00
Return on $50 stock	14%

Try It Yourself

Use our covered call screener to find opportunities on stocks you own. Filter by your purchase price to ensure you're selling calls above your cost basis.

In the next lesson, we'll discuss managing assignment risk and what to do when positions move against you.