If you’ve been spending any time in investing circles lately, whether that’s on social media, in investment forums, or even chatting with coworkers, you’ve probably heard about covered calls. This options strategy has been getting a lot of buzz, with some financial influencers touting it as a way to generate “passive income” from stocks you already own.
Before you jump into selling covered calls on your portfolio, let’s break down what this strategy actually is, why it’s suddenly everywhere, and whether it makes sense for your situation.
What Is a Covered Call?
A covered call is an options strategy where you sell someone else the right to buy your stock at a specific price (called the “strike price”) by a specific date. In exchange for giving them this right, you collect a payment upfront called a “premium.”
Here’s a simple example: Let’s say you own 100 shares of Apple stock currently trading at $80 per share. You could sell a covered call with a strike price of $85 that expires in one month. Someone might pay you $2 per share for this option (the premium), which is $200 total for your 100-share contract.
To summarize, with this contract, you have sold someone the right to buy your shares within the next month at $85. For this right, they have paid you $200.
Now one of two things will happen:
- Scenario 1: Apple stays below $85. The option expires worthless, and you keep your shares and the $200 premium. You can sell another covered call next month if you want.
- Scenario 2: Apple shoots up to $100. Here’s the catch: your shares get “called away” at $85 per share. You miss out on that run from $80 to $100. You still made money (your shares went from $80 to $85 before you were forced to sell them, plus you collected the $200 premium), but you gave up the extra $15 per share in gains above $85.
The key word is “covered.” You actually own the shares you’re writing the option on. This is very different from a “naked call,” where you’d sell call options on stock you don’t own, exposing yourself to unlimited risk.
Why Would Anyone Do This?
At first glance, this might seem odd. Why would someone pay you for the right to buy your stock later instead of just buying it now? And why would you limit your upside for a relatively small premium? Let’s look at both sides.
Why the buyer wants this deal:
The option buyer is making a leveraged bet. Instead of spending $8,000 to buy 100 shares of Apple at $80, they can spend just $200 for the right to buy those shares at $85. If Apple shoots up to $100, they can exercise their option, buy the shares at $85, and immediately have a profit (minus the premium they paid). Their $200 turned into a significant gain, whereas buying the stock outright would have required much more capital.
If they’re wrong and Apple never gets to $85, they’re only out the $200 premium instead of being stuck holding shares that might have gone down. It’s a way to get upside exposure without tying up as much money.
Why you, the seller, may want this deal:
You collect immediate income on shares you already own. Maybe you think Apple is fairly valued and likely to trade sideways for a while. That $200 premium is yours to keep, no matter what happens (as long as you don’t buy back the option). If you were planning to sell at $85 anyway, you’re essentially getting paid to place a limit sell order.
Plus, if the option expires worthless, you can turn around and sell another covered call the next month, creating an ongoing income stream from shares you’re holding long term.
The catch, of course, is that you’re giving up the big gains if the stock really takes off. That’s the trade-off: income now versus unlimited upside later.
Why Are Covered Calls Trending Right Now?
Several factors have pushed covered calls into the spotlight.
The Search for Income
With interest rates coming down from their recent peaks and many retirees or near-retirees looking for income, covered calls have been marketed as a way to squeeze extra cash from stocks you already own. Instead of just waiting for dividends, you can generate income by selling these options monthly or quarterly.
Social Media and Influencer Culture
Financial influencers have discovered that covered calls make for compelling content. It’s easy to show a screenshot of “I made $500 this week selling covered calls!” What’s harder to show is the opportunity cost of the big gains they missed when stocks rallied past their strike prices.
Volatility Creates Opportunity
Higher market volatility means option premiums are generally higher. When stocks are bouncing around more, buyers are willing to pay more for options, which makes covered calls more attractive to sellers.
Technology Makes It Easier
Modern brokerage apps have made options trading more accessible than ever. What used to require calling a broker and significant expertise can now be done with a few taps on your phone. This ease of access has democratized options trading, for better or worse.
What Covered Calls Are
Let’s be clear about what this strategy actually offers.
- A way to generate income from stocks you own. If you’re holding shares long term anyway, covered calls can produce extra cash flow.
- A strategy to add modest returns in sideways markets. When stocks aren’t going anywhere fast, those premiums can add up.
- A way to sell at your target price while getting paid to wait. If you were planning to sell at $190 anyway, why not collect a premium while you wait for it to get there?
- More conservative than owning stocks alone. The premium you collect provides a small cushion against losses. If that stock drops $2 but you collected $2 in premium, you’re roughly break-even.
What Covered Calls Are Not
This is where the marketing often diverges from reality.
- Not free money or passive income. You’re taking on real risk and making a real trade-off. You’re capping your upside in exchange for immediate income.
- Not appropriate for your best growth stocks. If you believe a stock could double, why would you cap your gains at 5% above the current price? Covered calls work best on stocks you expect to move sideways or slightly up.
- Not a substitute for a diversified portfolio. Some people get so excited about covered call premiums that they over-concentrate in a few stocks just to run this strategy. Bad idea.
- Not as simple as it sounds. There are tax implications, timing considerations, and decisions to make every time an option expires. This isn’t truly “set it and forget it.”
- Not risk-free. You still own the stock, which can go down. The premium provides only a tiny buffer against losses.
Final Thoughts
Covered calls are a real strategy used by sophisticated investors, but they’re also being oversimplified and oversold to everyday investors who might not understand what they’re giving up.
Before you start selling covered calls:
- Make sure you understand options fundamentals. Don’t learn with real money.
- Run the numbers. Calculate what you’d make in different scenarios, including if the stock surges.
- Consider the tax hit. Option premiums are usually taxed as short-term capital gains.
- Ask yourself why you own the stock. If it’s for growth potential, covered calls might work against that goal.
- Start small if you start at all. Try it with a small position to see if you actually enjoy the management and decision-making.
Remember, in investing, there’s no such thing as a free lunch. Covered calls offer income today in exchange for limited upside tomorrow. Whether that trade-off makes sense depends entirely on your goals, timeline, and the specific stocks involved.
Clark Howard’s Take: This isn’t a strategy Clark would recommend for the average investor. It’s complex, carries tax consequences, and can quietly chip away at your long-term growth. Clark’s advice remains the same as always: Stick with the tried and true basics, a diversified portfolio of low-cost index funds, automatic contributions, and a long-term mindset. Those simple steps have a far better track record than any short-term trading strategy that sounds clever in the moment.
