5 Key Things You Should Know About Covered Calls 📈💡

Covered calls are an options trading strategy that can provide steady income and offer some protection against stock price drops. If you're considering this strategy, it's important to understand how it works, its benefits, and its limitations.

In this article, we’ll break down everything you need to know about covered calls as we head into the New Year—here’s to making 2025 your best year yet with smarter investment strategies! 🎉

What Is a Covered Call?

A covered call involves owning 100 shares of a stock and selling a call option on that stock. A call option gives the buyer the right (but not the obligation) to buy the stock at a specific price (the strike price) before a set date (the expiration date). By selling this option, you collect a premium (income) in exchange for limiting your potential profit if the stock price rises beyond the strike price.

This strategy combines stock ownership with options trading, making it a way to generate extra income from a stock you already own. The downside? If the stock rises above the strike price, your profit is capped at the strike price plus the premium you received.

How Does a Covered Call Work?

Imagine you own 100 shares of stock XYZ, which is currently priced at $100 per share. You sell a covered call option with a strike price of $105 for $5 per share. Here's how it breaks down:

1. You receive $500 ($5 x 100 shares) for selling the call option.

2. If the stock price stays below $105 you keep the stock and the $500 premium.

3. If the stock price rises above $105, you profit $1000 as your shares may be "called away" (bought by the option holder) at $105, and you still keep the $500 premium.

The risk in this strategy is that if the stock price falls significantly, the loss in stock value can outweigh the premium you received. However, the premium can help offset some of that downside risk.

When to Use a Covered Call

Covered calls are ideal in a few specific situations:

1. Limited stock price movement: If you believe the stock will stay relatively flat or rise slightly, selling a covered call can be a good way to generate extra income without expecting huge gains from the stock.

2. Income generation: If you're holding a stock long-term and want to create a "dividend-like" income from the position, covered calls can be a solid choice.

3. Tax-advantaged accounts: If you're using a retirement account like an IRA, the premiums you receive from selling calls may grow tax-deferred, making it an attractive strategy in such accounts.

Pros and Cons of Covered Calls

Pros:

• Income generation: You collect premiums from selling the call option, adding extra income to your stock position.

• Reduced risk: The premium you receive can help offset some of the losses if the stock price falls.

• Easy to execute: Setting up a covered call is straightforward—just buy the stock and sell the call.

Cons:

• Limited upside: If the stock rises sharply, your gains are capped at the strike price plus the premium.

• Downside risk: If the stock price drops significantly, the premium might not be enough to offset your losses.

• Requires 100 shares: This strategy requires owning 100 shares of the stock, which means you need a higher initial investment.

Key Takeaways

Covered calls can be an effective way to generate income, especially in sideways or slightly bullish markets. By selling call options against stocks you already own, you can earn extra cash through premiums. However, the trade-off is limited profit potential and the risk of losing money if the stock price falls.

This strategy works best for investors looking to reduce downside risk while still earning some income from their long-term stock holdings. But remember, it’s important to carefully assess market conditions and your own risk tolerance before diving into a covered call strategy.

Now that you have a solid understanding of how covered calls can enhance your income, it’s time to take your trading skills to the next level. If you're looking to sharpen your strategies and discover a simpler, more effective way to generate daily income, you're in for a treat.

Join Iris Yuan, a seasoned trader with over a decade of experience, in her upcoming webinar: The 1-Hour-A-Day Stock Trading Formula for Daily Income. 

This session is tailored specifically for aspiring traders and busy professionals who want to stay ahead of the curve without getting bogged down by complex analysis.

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Iris will walk you through her techniques that deliver consistent results—no fluff, no complicated strategies, just actionable advice to help you maximise your returns with just an hour of trading a day.

Details
Date: 8th January 2025, Wednesday
Time: 8PM-9PM (GMT+8)

Don’t miss this opportunity to gain a competitive edge and start trading smarter. See you there!

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