How to Sell Covered Calls to Supplement Your Monthly Income

Are you looking for ways to supplement your investment earnings? One possible trading strategy is to learn how to sell covered calls. Covered calls can be used as a tool to help generate consistent monthly income, even in neutral stock markets.

Things You Will Need

online options trading account

Step 1 Covered Call Basics - In order to sell a covered call, you must first own at least 100 shares of the underlying stock for every call you intend to sell. Selling the call without owning the underlying asset is a strategy known as 'going naked', and is highly discouraged. Even professional traders are hesitant to sell naked calls.

When you sell a call option, you are selling the right, but not the obligation, to buy your stock at a certain price (known as the strike price) and on a certain date (known as the expiration date) to someone else. In essence, you are renting your stock to someone else and will collect a premium to do so.

Covered calls can be written three different ways:

1. Buy the underlying shares and then immediately sell the call - This is the most conservative method as you are not trying to time the market.

2. Write a call against stock positions that you already own - If you own shares of stock in your portfolio for which no call has been written, you are leaving money on the table. Think of it like owning a rental house but not renting it out. It is sitting there and may have some value, but it is not working to earn you money everyday.

3. Buy the underlying shares and then wait for an appreciation of the stock price to sell the call - Using this method of selling covered calls is exactly like trying to time the market. In the end you will lose more money with this technique.
Step 2 Execute the Transaction - Once you have decided upon your approach, execute the trade. As soon as you sell the call you will receive the premium income in your account. It is now necessary to wait until the expiration date to determine your next course of action.

If the stock price rising above the strike price, you will be called out. Your online broker will automatically sell your shares at the strike price to the buyer and deposit the proceeds into your account. You get to keep the premium income you earned and you are now free to repeat the process, buy yourself something nice or anything else you would like with the money.

If the stock price does not rise above the strike price, you will not be called out. You get to keep the premium income and are free to sell another call against these shares.
Step 3 Sell in-the-money calls - My personal preference is to sell either in-the-money calls, or slightly out-of-the money calls. This further reduces the risk of selling covered calls. As an example of in-the-money calls, assume that you own 100 shares of ABC stock, which is trading at $36, with a basis of $34. I would sell a near-month call at $35 ($1 in the money). This would result in a higher probability of me being called out AND would result in me earning a higher premium when I sell the call.

Selling covered calls is a powerful method of turbo-charging your portfolio's performance. Research the various techniques and option strategies before trying this with real money. All investments involve some risk, so it is always better to practice until you have a better understanding of the possible scenarios.

Tips & Warnings

Always seek the advice of a competent professional as investments of any kind involve some risk. This article is meant to depict my strategies and is not meant to be construed as investment advice.