I’ve written quite a bit about covered call options. I have a full section on them here.
What Are Options?
Options are derivatives. They derive their value from something else. In this case, the something else is another security.
I don’t like most derivatives and other complex securities because they are hard for me to understand, which means they are hard for me to make money on over the long term.
Covered calls however are pretty simple. I buy 100 shares of a stock that has option trading available. I need 100 because each option contract covers 100 shares. I immediately sell an option contract with a strike price higher than my purchase price. I usually try to sell a contract that expires in a month or less.
If the underlying stock’s price rises above the strike price on or before expiration date, the option buyer can compel me to sell my shares at the strike price and I get the premium plus the small gain. If the underlying stock’s price closes below the strike price at expiration, I keep my shares (and the option premium).
As long as the underlying stock is a company I like and that I am happy to hold through a pullback, and I never sell an option with a strike price below my purchase price, this is pretty low-risk strategy to earn some extra income.
If this interests you, check out the other posts for exactly how covered call options work and how I implement my low-risk strategy.
The Big Risk
The smaller risk, assuming I’m optimistic on the companies I buy for covered calls, and I’m willing to hold through pullbacks, is the hopefully-temporary pullback that all stocks go through at some point.
The big risk is the potential to miss out on huge gains.
I have been investing for over 40 years, and the majority of my current net worth comes from stock and mutual fund capital gains, not from salary and saving.
Capital Gains
Let’s take a quick time out and look at an example.
In 2007, I bought my first iMac computer. I was quite impressed so I took a look at the pre-iPhone Apple and decided to make a small investment. I bought 280 shares at a price of $4.49 per share. My total investment was $1,257.90.
Today’s AAPL price is $291.30. That’s more than a 6,000% gain. My gains on this single thousand dollar investment are over $80,000.
That was mostly luck; an idea based on my excitement about my new iMac, and a little research.
AAPL also pays a dividend, which I’ve reinvested in more shares, so over the course of my journey with Apple, I’ve netted an additional $64,000 in dividend income (most of this is cap gains from investing dividends at much lower stock prices.)
Option Capital Gain Risk
Back to risk…
What if I had sold a covered call option on those shares back in 2008? I probably would have been thrilled. I would have gotten a nice premium and I would have sold the shares at a small gain. In one month, I could net about a 3% – 4% return on investment. Annualized that’s 36% – 48%. That’s fantastic!!
But not as cool as the 354% annual return I achieved while holding AAPL shares for 18 years.
Today’s Option Bummer
I was a little disappointed this morning when I read
Roku is one of my favorite companies. It’s another that I decided to invest in after I tried and loved their product. Unlike Apple, Roku has been a wild ride.
I bought some shares early on which did well, sold them and then bought some later that did not-so-well. All told, I made some money on Roku. But I still love the company.
But back on 4/20/26, I thought I’d sell some covered call option contracts on my remaining 300 shares. These 300 shares had a pretty solid capital gain in my account, and I didn’t expect Roku to go much higher in the short term so I picked a high strike price with the hope that I’d keep the premium and the shares.
Here’s what the contracts looked like.
The options were sold at a strike price of $123. At the time, Roku was trading at about $115.
I got $1,500 in option premium right off the bat. And if Roku rose above the strike price, I’d get about an $8 per share capital gain from today, but $16,000 capital gain from when I bought the shares.
This looked good to me, but then the deal discussions started happening and Roku’s price increased, and then the deal is announced and shares shot up 20% in one day. I sold mine last month for $123 per share and the shares are trading at $143 today.
That’s $20 per share x 300 shares = $6,000 gain that I missed out on in exchange for a $1,500 option premium.
Wrap Up
I love using covered call options as a strategy for making some income.
But I am also very aware, and reminded by ROKU, that I need to consider the risk of missing out on capital gains.
I limit my exposure to covered call options. I ensure that I keep the vast majority of my equity investments in long positions that I will never sell covered calls against. I take a very small portion of my equity investment and buy stocks upon which to trade covered call options.
I have quite a few posts that describe the strategy in detail. Read more here.
But the key point to remember today is that covered call options limit our potential gain. While it’s a great strategy to earn some income, it is not a viable long term growth strategy. For that we need long-term investments in a basket of well-chosen equity funds and companies.
And to be clear, the point is not to beat ourselves up for these mis-steps. The point is to learn from them. I wish I hadn’t sold ROKU. But I have lots of examples of companies I sold due to covered calls which are worth much less today. We win some and we loose some.