What you will learn
Today is the Foundations block for covered calls. You will learn:
- What a covered call is in plain language
- The moving parts you control
- A clean example with real style numbers you can follow
- The basic return math and a quick way to think about probability
- The risk and reward profile
- A short broker checklist so you can practice safely
- What is coming next on PutSmith
My goal is to give you the freedom to write contracts that meet your needs. You set the terms. You collect the premium. You review the results. You improve with each cycle.
Covered calls in simple words
A covered call is an options contract you sell when you already own at least 100 shares of a stock or ETF. You agree to sell those shares at a chosen price, called the strike, if the stock reaches that price by the expiration date or finishes above it at expiration. In return, you collect money up front. That payment is the premium. One contract controls 100 shares.
If you own 100 shares, you can sell one contract. If you own 200 shares, you can sell two. Many brokerages support this, including Fidelity, Schwab, and Robinhood. You may need to enable options and confirm that you understand the risks.
The idea is straightforward. You trade some upside for cash today.
The four parts you control
You cannot control the market. You can control your plan. When you write a covered call, focus on four choices.
1) Ticker
Choose a stock or ETF you are willing to hold. Liquidity helps. Tight bid and ask spreads and steady volume make fills easier and exits cleaner. If the name makes you nervous, move on. There are plenty of tickers with active options.
2) Expiration date
This is how long the agreement lasts. Many investors start with about 30 days. Shorter contracts give faster feedback and smaller premiums. Longer contracts may pay more but keep you committed for more time.
3) Strike price
This is the price where you agree to sell your shares if assigned. A higher strike pays less premium but leaves more room for gains in the stock. A lower strike pays more premium but caps your upside sooner and raises the chance of assignment.
4) Limit price
Use limit orders. Set your ask near the mid price between the bid and ask, then nudge if needed. Avoid selling at market. A few dollars per contract adds up if you repeat the process.
You also control your exit plan. You can buy the call back early, roll it to a later date or different strike, or let it expire.
A clean example with Target (TGT)
Let us walk through a real style setup so the math is clear. Assume the stock price for Target is about $92 today. You own 100 shares, so your position value is $9,200. You plan to sell a one month covered call. Below are three choices. I am using round premiums to keep the math simple.
Choice A: 95 strike, about $120 premium
- Shares you own: 100
- Premium to you today: $120
- Strike: $95
- Days to expiration: about 30
Return math
- Monthly return on position value: 120 ÷ 9,200 = 1.30%
- Annualized if repeated: about 15.6%
- Share break even after premium: 92.00 − 1.20 = $90.80
Outcomes
- If Target stays at or under 95 at expiration, you keep the shares and the 120 dollars.
- If Target finishes above 95 and you are assigned, you sell at 95. Your share gain from 92 to 95 is $300, plus $120 premium, which is $420 for the cycle. That equals 4.56% on the 9,200 dollar position for that month.
Choice B: 97 strike, about $80 premium
- Premium: $80
- Monthly return: 80 ÷ 9,200 = 0.87%
- Annualized if repeated: about 10.4%
- More room before assignment. Lower premium than the 95 strike.
Choice C: 93 strike, about $170 premium
- Premium: $170
- Monthly return: 170 ÷ 9,200 = 1.85%
- Annualized if repeated: about 22.2%
- Higher premium, closer to the current price, higher chance of assignment, upside capped sooner.
What this shows
As you choose strikes closer to the stock price, premium rises but the chance of assignment rises too. As you choose strikes farther away, premium falls but you keep more upside room. You decide which mix fits your plan.
A quick way to think about probability
You can estimate the chance of assignment with a fast shortcut. Look at delta on the option chain. For a call option, delta is a rough proxy for the chance the option finishes in the money.
- If the 95 call shows a delta near 0.35, that suggests about a 35 percent chance it finishes above 95.
- Flip it around. About 65 percent chance you are not assigned.
This is an estimate. It is not perfect. It is still useful because you can scan a chain in seconds and compare strikes. Also remember that premium lowers your effective break even on the shares. In our 95 example, your adjusted break even for the month is $90.80, which gives a small cushion.
Risk and reward in plain view
What you can earn
- Premium up front. If you repeat monthly, small wins can add up.
- If the stock rises and you are assigned above your cost, you may also lock in a share gain.
What you give up
- Your upside is capped at the strike. If the stock runs far above your strike, you will not capture those extra gains.
Main risks
- The stock can drop. Premium helps but does not erase large moves down.
- Early assignment can happen, often around dividends, if the call goes deep in the money. It is not common, but it can happen.
Sizing and exits
- One contract uses 100 shares. If you own 160 shares, you might write only one contract to keep a buffer.
- Many traders close early at 50 to 80 percent of max profit to free up risk and write a new call.
- If you want to keep your shares and the call is in the money, you can buy it back for a loss and move on. If you are happy to sell, you can allow assignment and redeploy.
Covered calls feel reliable to many investors because the rules are clear and repeatable. You get paid up front. You choose the terms. You can adjust. You learn from each cycle. You do not need to be perfect. You need to be consistent.
Broker checklist you can follow today
Open your platform and walk through these steps.
- Confirm you own at least 100 shares of the stock you want to use.
- Open the option chain.
- Pick an expiration about one month out.
- Pick a strike that fits your plan.
- Place a Sell to Open order with a limit near the mid price.
- Confirm the contract size is 1 for each 100 shares.
Why this can be a first income stream
Covered calls are not magic. They are a process. The process rewards clear rules and steady execution. Here is why many people choose this as a first income stream.
- It is relatively simple to explain to yourself and to others (maybe not as simple as real estate, but once you figure it out, it definitely is)
- You see results on a set schedule
- You can choose risk that matches your goals
- You can scale up or down as your capital changes
- You can layer the approach on top of a long term portfolio
If your target is about 10 percent a year, you do not need to chase lottery wins. A one percent monthly target repeated across the year, with a few months better and a few months worse, can reach that range. The work is modest. The key is repeatability.
Notes on taxes and records
Tax rules vary by place and account type. Premiums from options you sell are usually short term. Keep clean records. Many brokerages export tax forms, but your own notes help you understand your plan. Note ticker, date, strike, expiration, premium, and your exit. A simple spreadsheet is enough at the start.
Where this goes next
I am building a dashboard that pulls the key parts into one view. The goal is a simple screener that surfaces tickers and strikes by:
- Probability of profit
- Simple monthly IRR and annualized return
- Capital tiers, so you can match trades to your budget
- Filters such as industry, time to expiration, and your target return
A functional tool is coming. For now, use the table in this post to practice the math and the logic.
Wrap up
Today you learned the basics of covered calls. You own 100 shares. You sell a call. You collect premium up front. You control the ticker, the expiration, the strike, and your limit price. We walked a Target example, did the return math, and lined up the risk and reward so you can see why this method feels reliable when you follow clear rules.
Keep your notes. Size small. Practice consistency.
Next episode and post: cash secured puts. You get paid while you wait for a price you want. We will pick strikes, run simple IRR and probability checks, and talk through exits. I will also introduce capital tiers so you can match trades to your budget.
If this helped, share it with one person who wants clear steps for options income. You can find the PutSmith page on Pharmacist Write for notes and updates.
