Ready to potentially generate some income from your stock holdings? Excellent! This comprehensive guide will walk you through the process of writing a covered call on E*TRADE, step by step. It might seem a bit daunting at first, but by the end of this, you'll have a clear understanding and the confidence to execute this strategy.
Let's dive in!
Understanding the Covered Call Strategy
Before we get into the "how-to," let's quickly recap what a covered call is.
A covered call is an options strategy where you sell call options against shares of stock you already own. The "covered" part means you own the underlying stock, which mitigates the risk of unlimited losses if the stock price skyrockets.
Here's the basic idea:
You own 100 shares (or multiples of 100) of a particular stock.
You believe the stock's price will remain relatively stable or even decline slightly in the short term.
You sell a call option, giving the buyer the right (but not the obligation) to purchase your shares at a specific price (the "strike price") before a certain date (the "expiration date").
In return for selling this right, you receive a premium (income).
The catch? If the stock price rises above the strike price by the expiration date, your shares will likely be "called away" (sold) at the strike price, and you'll miss out on any further gains beyond that price.
Why use it?
Income Generation: The primary reason is to generate income from your existing stock holdings.
Reduced Cost Basis: The premium received effectively lowers the cost basis of your shares.
Limited Risk (if covered): Since you own the underlying stock, your downside is limited to the initial premium received if the stock stays below the strike.
Getting Started on E*TRADE: Pre-Requisites
Before you can even think about writing a covered call on E*TRADE, there are a couple of things you need to ensure are in place:
An E*TRADE Account: This one's obvious! If you don't have one, you'll need to open one and fund it.
Options Trading Approval: This is crucial. E*TRADE requires you to apply for and receive approval for options trading. This involves answering questions about your financial situation, trading experience, and risk tolerance. Typically, writing covered calls (Level 1 or Level 2 options trading) is one of the easier levels to get approved for.
To check your approval status: Log in to E*TRADE, navigate to your account settings, and look for "Options Trading Agreement" or similar. If you're not approved, follow the prompts to apply. It might take a few business days for approval.
Shares of Stock: You need to own at least 100 shares (or multiples thereof) of the stock you want to write a covered call against. Remember, one options contract typically controls 100 shares of the underlying stock.
Step 1: Log In and Navigate to the Options Chain
Alright, let's get hands-on!
Open your web browser and go to the E*TRADE website.
Log in to your account using your username and password.
Once logged in, you'll typically land on your portfolio overview or dashboard.
Look for a search bar or a "Trade" menu option.
Enter the ticker symbol of the stock you own and wish to write a covered call on (e.g., AAPL for Apple, MSFT for Microsoft).
After entering the ticker, you'll likely be taken to the stock's quote page.
On this page, look for tabs or links related to "Options," "Options Chain," or "Trade Options." Click on it!
Congratulations! You've taken the first active step in exploring covered calls on ETRADE!*
Step 2: Analyze the Options Chain and Choose Your Contract
This is where the real decision-making happens. The options chain will display a dizzying array of call and put options for various expiration dates and strike prices. Don't be overwhelmed!
Sub-heading: Understanding the Options Chain Layout
The options chain will typically be divided into two main sections: calls on the left, puts on the right. For covered calls, we're focused on the call options side.
You'll see columns with information like:
Strike Price: The price at which the option buyer can buy your shares.
Expiration Date: The date the option contract expires.
Last (Price): The price at which the option last traded.
Bid: The highest price a buyer is currently willing to pay for the option.
Ask: The lowest price a seller is currently willing to accept for the option.
Volume: The number of contracts traded today.
Open Interest (OI): The total number of open contracts outstanding.
Sub-heading: Key Decisions for Your Covered Call
Now, let's make some strategic choices:
Choose an Expiration Date:
Short-term (e.g., 1-4 weeks): Offers smaller premiums but allows for more frequent income generation and quicker adjustments. Less time for the stock to move significantly.
Mid-term (e.g., 1-3 months): A good balance of premium and time.
Long-term (e.g., 3+ months): Larger premiums but ties up your shares for longer and exposes you to more potential for the stock to move significantly.
Consider volatility: If the stock is highly volatile, you might prefer shorter-term options to reduce the risk of your shares being called away at an undesirable price.
Remember: The further out the expiration date, the higher the premium generally is, due to more time value.
Select a Strike Price: This is arguably the most critical decision.
In-the-Money (ITM) Strike: A strike price below the current stock price.
Pros: Offers a higher premium.
Cons: Higher probability of your shares being called away. You're effectively selling your shares at a loss compared to the current market price if they are called away.
At-the-Money (ATM) Strike: A strike price equal to or very close to the current stock price.
Pros: Good balance of premium and probability of being called away.
Cons: Still a decent chance of being called away.
Out-of-the-Money (OTM) Strike: A strike price above the current stock price.
Pros: Lower probability of your shares being called away. You get to keep your shares and the premium if the stock stays below the strike. Allows for some upside appreciation before being called away.
Cons: Offers a lower premium.
General Rule of Thumb for beginners: Many covered call writers prefer to sell Out-of-the-Money (OTM) calls. This gives you some cushion if the stock price rises and increases the likelihood of keeping your shares and the premium. Consider what price you would be comfortable selling your shares at.
Review the Premium (Bid Price):
When you sell an option, you receive the bid price. The options chain will show both a Bid and an Ask. We want to see the Bid price for the specific strike and expiration you're considering.
Multiply the Bid price by 100 (since one contract covers 100 shares) to see the total premium you would receive per contract. For example, if the bid is $1.50, you'd receive $150 per contract.
Take your time here. This is where your strategy comes to life!
Step 3: Initiate the Trade
Once you've zeroed in on your desired expiration date and strike price, it's time to place the order.
On the options chain, click on the "Bid" price of the specific call option you want to sell. E*TRADE's interface will then typically pre-populate an order ticket for you.
Sub-heading: Configuring Your Order Ticket
Review the order ticket carefully. Here's what you'll typically see and need to confirm/adjust:
Action: This should be set to "Sell to Open." This indicates you are initiating a new short position in this option.
Quantity: This refers to the number of options contracts. Remember, one contract covers 100 shares. So, if you own 500 shares, you can sell up to 5 contracts. Be precise here!
Option Type: Should be "Call."
Expiration Date: Confirm this matches your chosen date.
Strike Price: Confirm this matches your chosen price.
Order Type:
Limit Order (Recommended): This allows you to specify the exact price (premium) you want to receive. If the market isn't willing to pay that much, your order won't fill.
Set your limit price: Start with the current Bid price. You might try to get a slightly higher price (e.g., between the Bid and Ask), but be aware it might not fill immediately.
Market Order (Use with Caution): This executes immediately at the best available price. While fast, you might receive less premium than you anticipated, especially for less liquid options. Generally, avoid market orders for options.
Time in Force:
Day: The order is active only for the current trading day. If it doesn't fill, it expires at the end of the day.
Good 'til Canceled (GTC): The order remains active until it's filled or you manually cancel it.
Sub-heading: Review and Confirm
Double-check all the details on your order ticket: stock symbol, option type, expiration, strike, quantity, action (Sell to Open!), limit price, and time in force.
E*TRADE will often provide an estimated credit (the premium you'll receive). Make sure this looks correct.
Click "Preview Order" or similar.
Read the preview carefully. It will show you the potential credit and any commissions/fees.
If everything looks correct and you're comfortable, click "Place Order" or "Send Order."
Congratulations! You've successfully placed your covered call order!
Step 4: Monitoring Your Covered Call
Once your order is filled (you'll receive a confirmation), the work isn't entirely over. You need to monitor the position.
Check your portfolio: Your covered call position will now show up in your E*TRADE portfolio, typically under a separate "Options" section. It will show as a "short" position because you sold the option.
Sub-heading: What to Watch For
Stock Price Movement: Keep an eye on the underlying stock's price.
If the stock stays below the strike price: Good news! The option will likely expire worthless, and you keep the entire premium. Your shares are safe.
If the stock rises above the strike price: Your shares are at risk of being called away.
Time Decay: Options lose value as they get closer to expiration. This "time decay" (theta) is generally beneficial for option sellers.
Volatility Changes: Implied volatility can affect the option's premium. An increase in volatility will generally increase the option's value (bad for sellers), and a decrease will lower it (good for sellers).
Sub-heading: Managing Your Position
You have a few choices as expiration approaches:
Let it Expire Worthless: If the stock price is below the strike price at expiration, the option expires worthless, and you keep the full premium. This is often the desired outcome.
Buy Back the Option (Close the Position): If the stock price rises and you don't want your shares to be called away, or if the option premium has decreased significantly, you can "buy to close" the option. This means you buy back the same option you sold, hopefully at a lower price than you sold it for, thereby realizing a profit (or limiting a loss if the premium increased).
To do this, navigate to your "Options" positions, select the option you sold, and choose "Buy to Close" or "Close Trade."
Roll the Option: If the stock is hovering near or above the strike price, and you want to avoid assignment while still generating income, you can "roll" the option. This involves:
Buying back your existing short call option (closing the current position).
Selling a new call option with a later expiration date and/or a higher strike price.
The goal is usually to do this for a "net credit" (meaning you receive more premium for the new option than it costs to close the old one).
Allow Assignment (Shares Called Away): If the stock price is above the strike price at expiration, your shares will likely be called away. This means they will be automatically sold at the strike price. You keep the premium received from selling the call, and you sell your shares at the strike price.
Remember: You sold the option for a reason, and assignment is a possible (and sometimes desired) outcome.
Monitoring and managing are key to successful options trading.
Step 5: After Expiration or Assignment
What happens next depends on how the option behaved:
Sub-heading: If the Option Expires Worthless
You keep the premium: The full premium you received is yours to keep.
You keep your shares: Your shares remain in your account, and you are free to write another covered call on them if you wish, or pursue other strategies.
This is often the most desirable outcome for income-focused covered call writers.
Sub-heading: If Your Shares Are Called Away (Assigned)
Your shares are sold: You will see a debit in your account for the shares that were sold at the strike price. The profit or loss on the stock will be calculated based on your original purchase price vs. the strike price.
You keep the premium: The premium you received from selling the call partially offsets the cost basis of your shares.
You no longer own those shares. If you want to continue owning the stock, you'll need to buy it back on the open market, potentially at a higher price than you sold it for.
Risks of Writing Covered Calls
While covered calls are considered a relatively conservative options strategy, they are not without risks:
Limited Upside Potential: The primary downside is that you cap your potential gains if the stock price skyrockets beyond your strike price. You'll sell your shares at the strike, missing out on further appreciation.
Opportunity Cost: Your capital is tied up in the shares, and you might miss other investment opportunities.
Stock Price Decline: If the stock price falls significantly, you still own the shares, and the premium received only partially offsets the loss in the stock's value. You can still lose money on the stock itself, even with the premium.
Early Assignment: Though rare for OTM calls, options can be assigned early, especially if there's an ex-dividend date coming up and the option is ITM.
Frequently Asked Questions (FAQs)
How to choose the right stock for a covered call?
Look for stocks you already own, are comfortable holding long-term, and believe will remain relatively stable or have limited upside in the short to medium term. Avoid highly volatile stocks for beginners.
How to select the best expiration date for a covered call?
Consider your outlook on the stock and your desired income frequency. Shorter-term options (1-4 weeks) offer frequent income and less time for significant price movement, while longer-term options offer higher premiums but tie up your shares for longer.
How to determine the ideal strike price for a covered call?
Many beginners prefer out-of-the-money (OTM) strikes to reduce the likelihood of assignment and allow for some upside. Consider what price you would be comfortable selling your shares at if they are called away.
How to calculate the potential profit from a covered call?
The potential profit is the premium received minus any commissions. If your shares are called away, your total profit is the premium received plus the difference between your cost basis and the strike price (if positive).
How to close a covered call position early on E*TRADE?
Go to your E*TRADE portfolio, navigate to your options positions, find the covered call you sold, and select "Buy to Close" to buy back the option at the current market price.
How to roll a covered call on E*TRADE to avoid assignment?
To roll, you'll "Buy to Close" your existing short call and simultaneously "Sell to Open" a new call with a later expiration date and/or a higher strike price. E*TRADE often has a dedicated "Roll" feature for this.
How to handle a covered call that goes deep in-the-money?
If the stock price surges far above your strike, your shares will almost certainly be called away. You can either let them be assigned or buy back the option (likely at a loss on the option) if you want to keep the shares, but this might not be financially beneficial.
How to manage a covered call when the stock price falls?
If the stock falls, the option premium will decrease. You can either let the option expire worthless, or "buy to close" the option for a small profit (or minimal cost) and then write a new covered call at a lower strike price or the same strike with a different expiration.
How to understand the risks associated with covered calls?
The primary risks include capping your upside potential, missing out on significant stock appreciation, and still incurring losses on your underlying stock if its price declines significantly.
How to view my covered call assignments on E*TRADE?
If your shares are called away, you will receive a notification from E*TRADE, and your portfolio will reflect the sale of the shares at the strike price. You can typically view your trade confirmations and statements for details.