When it comes to generating steady income from stocks, selling covered calls is one of my favorite strategies.
It’s a powerful way to put your shares to work for you—collecting cash flow month after month. But is it truly safe? Can you lose money selling covered calls?
Let’s break it down in plain English.
What Is a Covered Call?
Think of it like this: Imagine you own a pair of football tickets. You decide to sell someone the right to buy those tickets from you at a set price, any time between now and game day.
In exchange, they pay you cash upfront.
If they use that right, you hand over the tickets at the agreed price. If not, you keep both the tickets and the cash.
Covered calls work the same way. I own at least 100 shares of a stock. I sell a call option, which gives someone else the right (but not the obligation) to buy my shares at a specific price (the “strike price”) by a certain date.
For granting that right, I collect a premium—real cash in my account, no matter what happens next.
Why I Consider Covered Calls Conservative
Covered calls are often called a “conservative” options strategy, and for good reason:
- Lowering My Cost Basis: The premium I collect reduces the effective price I paid for my shares. If I buy a stock at $50 and sell a call for $2, my net cost is now $48. That $2 is like instant cash flow and a buffer against small price drops.
- Steady Cash Flow: I’m not just hoping the stock goes up. I’m getting paid for owning it—month after month. This is what I call “cash flow investing,” and it’s the heart of my approach to stocks.
- No Leverage, No Guesswork: I’m not borrowing money or making wild bets. I’m using what I already own to generate income, which makes this strategy suitable even for retirement accounts.
So, Can You Lose Money?
Here’s the honest truth: Covered calls are conservative, but not risk-free.
There are two main ways you can lose money:
1. If the Stock Drops
If the stock price takes a dive, the premium I collected helps cushion the blow, but it doesn’t eliminate the loss.
For example, if I buy a stock at $50, sell a call for $2, and the stock falls to $40, my net loss is $8 per share ($50 – $40 – $2 = $8).
The risk of owning the stock doesn’t go away just because I sold a call.
2. If the Stock Soars
If the stock price shoots up past my strike price, I have to sell my shares at that agreed-upon price.
That means I miss out on any gains above the strike price. For instance, if I sell a $55 call on a stock I bought at $50, and the stock jumps to $70, I still have to sell at $55. I keep my premium and the profit up to $55, but I give up everything above that.
How I Manage the Risks
Over the years, I’ve developed a few habits to help manage these risks:
- Using Collars: Sometimes, I’ll use part of the premium from selling a call to buy a protective put. This “collar” strategy limits both my upside and my downside, which is especially useful around big events like earnings announcements.
- Choosing the Right Strike Price: I like to pick strike prices that are just above my purchase price. This lets me collect a decent premium while still leaving room for some capital appreciation.
- Buying Back the Call: If the stock makes a big move and I want to keep my shares, I can buy back the call option before expiration. Sometimes it costs me, but it gives me flexibility.
My Bottom Line
Covered calls are a cornerstone of my cash flow strategy.
Yes, you can lose money if the stock falls, and you do cap your potential gains if the stock surges.
But for investors who want to generate steady income and are willing to accept those trade-offs, covered calls are a powerful tool.
If you’re just starting out, focus on quality stocks and use covered calls to collect “accelerated dividends.”
Learn the basics, practice with small amounts, and remember: It’s about building wealth one premium at a time.