If you're holding stocks that aren't doing much, you might be wondering whether there's a way to earn income while you wait for them to move. That's where covered calls come in.
A covered call is an options strategy that lets you sell (or "write") call options against the underlying stock you already own. You give someone the right — not the obligation — to buy your shares at a specific price (the " strike price ") by a specific date (the " expiry date "). In exchange, you collect a cash payment called the premium — and you keep that premium no matter what happens next.
This article covers how covered calls work, when the strategy makes sense, the risks involved, and what to consider before you write your first one.
How covered calls work
A covered call involves selling a call option on shares you already own, collecting a premium upfront in exchange for agreeing to sell those shares at the strike price if the option is exercised. You typically write a covered call when you believe the stock price will stay relatively flat or rise modestly — it's a way to earn income on shares you're already holding.
You should be selective on which stocks you write a covered call against, as the premium may or may not be enough to offset a loss on the stock or a missed opportunity if the price rises further than you anticipate.
For example, you own shares of a stock currently selling for $100 per share. You set your strike price at $110 with a 45-day expiry and earn a $5 premium by selling the call. Most options contracts are for 100 shares, so you'd make $500 selling this call.
If, when the option expires 45 days later, the stock is trading at $115, the buyer might choose to exercise the option. You keep the premium, but you're obligated to sell the shares at the strike price. This process is known as assignment.
If the stock price stays the same or drops, the option expires worthless. You keep your premium and your shares.
Covered call example
Let's say you hold a large bunch of $BANANAS stock in your Tax-Free Savings Account (TFSA). You've got a pretty good feeling that the stock price will rise in the next few months. You'd like to earn a little extra money while you wait, so you decide to write a covered call option. You set the strike price at $110 — $10 higher than the current stock price of $100 — on an option that expires in 45 days. For writing the call option, you make a premium of $5 per share.
What if the stock hits the strike price?
Turns out, your hunch on the bunch was correct. The price of $BANANAS stock rises to $110. If the option is exercised, meaning you sell 100 shares at $110 per share, you make a total profit of $15 per share: $110 (strike price) minus $100 (original price) plus $5 (premium). Since options generally represent 100 shares, your total profit becomes $1,500.
What if the stock price exceeds the strike price?
If $BANANAS go bananas and the stock price rises to $115, the option buyer will almost certainly exercise. Your profit is capped at $15 per share because you have to sell at the strike price of $110. You still earn the $10 appreciation plus the $5 premium, but you miss out on any gains above the strike price. By contrast, if you'd simply held the shares without writing the covered call, you'd have gained $15 per share ($1,500 total) from the stock's appreciation alone — $500 more than the $1,000 stock gain you're allowed to keep after assignment, even after factoring in the $500 premium.
What happens if the stock price stays the same?
If $BANANAS stay steady at $100 per share, the option expires worthless. You walk away with your $5 per share premium and keep your shares without having realized any gains or losses.
What happens if the stock price goes down?
If $BANANAS falls to $90 per share, the premium you earned helps offset your losses — a $10 unrealized loss per share plus a $5 premium brings the potential loss down to $5 per share. You don't need to sell your shares and realize that loss; you could hold onto them in the hopes $BANANAS start to grow again.
When to use a covered call strategy
A covered call strategy works when you have a neutral to mildly bullish outlook on a stock you already own. You're not expecting a big move up or down — you just want to earn some extra income while you wait.
This strategy tends to suit investors who:
Own shares they're comfortable selling. Since you might be obligated to sell at the strike price, you should be okay with that outcome.
Want to generate income in flat markets. If a stock has been sitting still, selling covered calls lets you earn premiums instead of just watching the ticker.
Have a target exit price in mind. If you've been thinking about selling at a certain price anyway, a covered call can help you get paid while you wait.
This strategy probably isn't for you if you expect a stock to rise sharply — you'd cap your gains at the strike price and miss the upside. It isn't ideal for highly volatile stocks where big price swings are likely.
How to choose a strike price and expiry date
Two decisions shape every covered call: the strike price you set and the expiry date you choose. Both involve trade-offs between how much premium you collect and the likelihood your shares get called away.
Strike price
Most covered call sellers choose an out-of-the-money strike — a price above the stock's current market price. The further out of the money you go, the less premium you'll collect, but the more room the stock has to rise before your shares are called away.
Higher strike price. Lower premium, but more upside potential and lower chance of assignment.
Lower strike price (closer to current price). Higher premium, but greater chance the option gets exercised and your shares are sold.
Expiry date
Longer-dated options generally pay higher premiums, but they tie up your shares for a longer period. Many covered call sellers choose expiry dates 30 to 60 days out, which tends to balance decent premium income with a manageable time commitment.
The right combination depends on your goals. If income is the priority, lean toward a closer strike and shorter expiration so you can sell calls more frequently. If you'd rather hold onto your shares, a higher strike gives you more breathing room.
Benefits of selling covered calls
A covered call strategy can offer a few key advantages:
You earn the premium. No matter whether the call is exercised or not, you'll receive a premium for writing the option. If you're selling an option of 100 shares with a premium of $0.75 per share, you'll make $75 per contract.
Your premium can offset small losses. If the stock drops between the time you write the option and the expiry date, the premium helps cushion that decline.
You can set a target exit price. If you've been considering selling your shares at a certain price, you could sell a covered call at that price instead of placing a limit order. If the stock reaches the strike, your shares are sold — same outcome, but you pocket the premium too.
Risks and misconceptions of selling covered calls
Covered calls are sometimes described as a "safe" or "conservative" options strategy — and while they do carry less risk than many other options plays, that framing can be misleading. The premium you collect isn't free money; it comes with a trade-off that can cost you if the stock moves in unexpected ways. Most brokerages also require you to apply for options trading approval and complete a suitability assessment before you can start writing covered calls.
Here are the key risks to keep in mind:
Stock prices can fall. You're writing a covered call against shares you own, and stock prices can fluctuate. Owning stocks comes with its own set of risks, and the premium you collect provides only a small cushion.
You could miss out on significant gains. If the stock price rises well above your strike price, you're still obligated to sell at the strike. That means you miss out on the additional profit. Consider whether the premium compensates you enough for capping your potential upside.
Assignment can happen at any time. If the stock price moves above your strike price before expiry, the option buyer can exercise early — particularly around ex-dividend dates.
Rolling a covered call
Rolling a covered call means closing your current option position and opening a new one — usually with a different strike price, expiry date, or both. It's a way to extend or adjust the strategy without giving up your shares.
There are a few common ways to roll:
Rolling out. You keep the same strike price but push the expiry date further into the future. This works when the stock price hasn't changed much and you want to collect more premium.
Rolling up. You move to a higher strike price (with the same or later expiration). This makes sense if the stock has risen and you want to avoid assignment.
Rolling down. You move to a lower strike price. This is less common but can help you collect more premium if the stock has dropped.
Rolling isn't free — you'll pay to close the old position and open the new one. Whether it's worth it depends on how much additional premium you can collect versus the transaction costs.
Covered calls vs. naked calls
The key difference between a covered call and a naked call is whether you own the underlying stock. When you sell a covered call, you're writing an option on shares you own. When you sell a naked call, you're writing an option on shares you don't own.
If the strike price is reached and the option is exercised on a naked call, you have to go to the market and buy the shares at whatever the current price is in order to fulfil the contract. If the stock price has risen substantially, your losses can be significant — potentially unlimited as the stock climbs. Naked calls are a higher-risk strategy typically used to generate premium income.
The bottom line
A covered call is one of the more straightforward options strategies — but that doesn't mean it's risk-free. Before selling your first covered call, make sure you're comfortable with the possibility of giving up your shares at the strike price, and that the premium you're collecting is worth that trade-off.
If you're already holding stocks you believe in for the long term and looking for a way to generate income while you wait, covered calls can be a practical tool to add to your investing toolkit. Start with a stock you know well, choose a strike price you'd be happy selling at, and keep an eye on the position as expiry approaches.
