Covered call: how we sell calls on our shares

What is a covered call

You own 100 shares and sell a call against them. You collect a premium and, in exchange, if the stock is above the strike at expiration, your shares are called away at that price. If not, the call expires worthless, you keep the premium, and you still hold the shares to sell another call.

At MTO, most of our shares come from puts that were assigned to us, often within the MTO Wheel Spread. The covered call is how we keep collecting premium while we hold them.

Rule 1: always above your average price

When we sell a call, we accept that our shares can be called away. That's why we always sell it above our break-even (purchase price minus the premiums collected). If the shares are called away, we make money. If the stock rallies hard and we miss out on further gains, we don't lose sleep over it: that was the deal. If we don't want to sell the shares, we don't sell a call.

Rule 2: if the premium isn't worth it, we wait

When the stock has dropped and is far from our average price, calls above that price pay very little. A real case: with shares at an average price of $12.62 and the stock trading well below that, the premiums above that price weren't worth it, so we preferred to wait for the stock to confirm a recovery. Another: if our last call was sold at the 15 strike, 45 days out, for $0.62, it makes no sense to sell an 11 strike now for $0.30 just because the stock has fallen.

Waiting is also a decision: selling a cheap call caps the stock's recovery in exchange for almost nothing.

Rule 3: roll up by raising the strike if we believe in the stock

If the stock approaches the strike and we think it will keep rising or hold its level, we roll the call out to a later expiration and raise the strike: every dollar higher is an extra $100 if the shares are eventually called away. If we think it's going to fall, we let the shares be called away. More detail in rolling options.

Long calls instead of shares

You can also sell calls against long calls (what's usually called a poor man's covered call). For example, with 100 shares and 3 long calls you can sell up to 4 calls. Be careful: if a short call that is covered only by a long call gets assigned, you end up short 100 shares, which you can close out by exercising the long call. Mario explains it in depth in his poor man's covered call tutorial (in Spanish).

The PATH case

In the full MTO Wheel Spread example, after the assignment we sold two calls (strikes 11 and 11.50) above an effective price of $9.53. The second one was assigned and we sold the shares at $11.50, closing the entire strategy with +$224.72. You can follow it step by step in MTO Wheel Spread.