Hey there, future income generator! Are you tired of just letting your shares sit there, hoping they'll appreciate in value, while missing out on potential income? Well, get ready, because we're about to dive deep into the world of covered calls on E*TRADE, a powerful strategy that can help you generate consistent income from stocks you already own.
This isn't just about making a quick buck; it's about learning a disciplined approach to options trading that can enhance your portfolio's returns. So, are you ready to unlock this potential? Let's get started!
How to Do Covered Calls on E*TRADE: A Step-by-Step Guide
Covered calls are a popular options strategy where you sell call options against shares of stock you already own. The "covered" part means you own the underlying shares, which mitigates the risk of unlimited losses typically associated with selling naked (uncovered) call options. In essence, you're agreeing to sell your shares at a specific price (the strike price) by a certain date (the expiration date) in exchange for an immediate payment (the premium).
This strategy is ideal for investors who are neutral to slightly bullish on a stock they hold, or those who are simply looking to generate additional income from their existing holdings.
Step 1: Understand the Core Concepts – Are You Ready to Learn?
Before we even touch E*TRADE, it's crucial to grasp the fundamental building blocks of a covered call. This isn't just theory; it's the foundation of your success.
What is a Covered Call?
A covered call involves two main components:
Owning 100 shares of a stock (or an ETF): Each option contract typically controls 100 shares of the underlying asset. So, to sell one covered call contract, you need to own at least 100 shares of that particular stock.
Selling a Call Option: When you "sell to open" a call option, you are granting someone else the right, but not the obligation, to buy your 100 shares at a predetermined price (the strike price) on or before a specific date (the expiration date). In return for granting this right, you immediately receive a cash payment, known as the premium.
Why Use a Covered Call?
Generate Income: This is the primary reason. The premium you receive is immediate income, regardless of what happens to the stock price (as long as the option isn't exercised early).
Potential for Higher Selling Price: If the stock rises to your strike price and gets "called away" (exercised), you effectively sell your shares at the strike price plus the premium received, which could be higher than the current market price.
Partial Downside Protection: The premium you receive acts as a small cushion against a potential drop in the stock price. If the stock falls, you still keep the premium, which offsets some of your losses.
The Trade-Off: Limited Upside Potential
While covered calls offer income and some protection, they also cap your upside potential. If the stock skyrockets past your strike price, you'll miss out on any gains above that price, as your shares will be called away at the strike price.
Step 2: Selecting the Right Stock and Options Contract on E*TRADE
Now that you're armed with the basics, let's talk about how to apply this on E*TRADE. This step is about careful selection, not impulsive trading.
Choosing the Right Underlying Stock
Stocks You Already Own and Are Comfortable Selling: The best candidates for covered calls are stocks you already hold and are comfortable selling at a slightly higher price. Don't write calls on stocks you believe have significant near-term upside, as you'll cap your profits.
Relatively Stable Stocks: Highly volatile stocks can be risky for covered calls. Look for stocks that tend to trade within a range or have a slight upward bias.
Stocks with Good Options Volume: Ensure there's sufficient liquidity in the options market for your chosen stock. This means a narrow bid-ask spread and decent trading volume, making it easier to enter and exit positions. E*TRADE's platform provides tools to check this.
Picking the Right Call Option (Strike Price and Expiration Date)
Once you've chosen your stock, it's time to select the specific call option to sell. This is where strategy comes into play.
Strike Price:
Out-of-the-Money (OTM): A strike price above the current stock price. This is generally preferred for covered calls as it allows for some stock appreciation while still collecting premium. If the stock stays below the strike, you keep your shares and the premium.
At-the-Money (ATM): A strike price equal to the current stock price. These options generally have higher premiums but a higher chance of being assigned.
In-the-Money (ITM): A strike price below the current stock price. These options offer the highest premiums but almost guarantee your shares will be called away. They're typically used if you actively want to sell your stock at a specific price now.
Consider your outlook: If you're slightly bullish, go for an OTM strike. If you're purely looking for income and don't mind selling your shares, an ATM or slightly ITM strike might be considered.
Expiration Date:
Short-Term (e.g., 1-4 weeks): These options have less time decay to benefit from but generally offer lower premiums. They require more frequent management.
Mid-Term (e.g., 1-3 months): A common sweet spot. They offer a good balance of premium and time decay.
Long-Term (LEAPS): While covered calls can be written with LEAPS, it's less common for income generation due to the slower time decay.
Consider your timeframe: How long are you willing to have your shares potentially tied up or sold? Shorter-term options give you more frequent premium collection but more active management.
Step 3: Navigating E*TRADE to Place Your Covered Call Order
Alright, let's get hands-on with the E*TRADE platform. The process is generally straightforward once you know where to look.
Log In to Your E*TRADE Account: Access your brokerage account on the ETRADE website or through their Power ETRADE platform/app.
Locate the Stock You Own: Navigate to your portfolio or search for the stock ticker of the shares you intend to write a covered call against.
Access the Options Chain:
On the stock's detail page, look for an "Options" or "Options Chain" tab/link.
This will display a table of available options contracts for that stock, organized by expiration date and strike price. You'll see both call and put options. We are interested in the call options.
Select Your Desired Expiration and Strike Price:
Click on the expiration date that aligns with your strategy.
Identify the call option with the strike price you've chosen.
You'll see "Bid" and "Ask" prices for each option. The "Bid" is the price buyers are willing to pay, and the "Ask" is the price sellers are willing to accept. When selling, you'll typically aim for a price closer to the bid.
Initiate the "Sell to Open" Order:
Click on the "Bid" price of the call option you want to sell. This will typically pre-populate an order ticket.
Crucially, ensure the "Action" is set to "Sell to Open." This means you are creating a new short options position. Do NOT select "Buy to Open" or "Sell to Close" at this stage.
Configure Your Order Ticket:
Quantity: Enter the number of contracts you want to sell. Remember, each contract represents 100 shares, so if you own 200 shares, you can sell 2 contracts.
Order Type:
Limit Order (Recommended): This allows you to specify the exact premium you want to receive. Your order will only execute if that price (or better) is available. This is generally preferred for options trading to ensure you get a fair price.
Market Order: Executes immediately at the best available price. While fast, you risk getting a less favorable premium, especially on less liquid options. Use with caution.
Price: If you chose a limit order, enter your desired premium per share.
Time in Force:
Day: The order is active only for the current trading day.
Good 'Til Canceled (GTC): The order remains active until it's filled or you cancel it (typically up to 60 days on E*TRADE).
Review and Confirm Your Order:
Carefully review all the details of your order: stock, expiration, strike price, action (Sell to Open), quantity, order type, and price.
E*TRADE will often show you a summary of the trade, including the potential premium you'll receive.
Click "Preview Order" or "Review Order" and then "Place Order" or "Submit Order."
Congratulations! You've just placed your first covered call order on ETRADE!*
Step 4: Monitoring and Managing Your Covered Call Position
Placing the order is just the beginning. Active management is key to successful covered call trading.
What to Monitor:
Stock Price Movement: Keep an eye on how the underlying stock is performing relative to your strike price.
Option Premium Value: The value of the option premium will fluctuate based on the stock price, time until expiration (time decay), and volatility.
Time Decay (Theta): Options lose value as they approach expiration. This benefits option sellers.
Dividend Dates: Be aware of ex-dividend dates. If your option is deep in-the-money and there's an upcoming dividend, there's a higher chance of early assignment (your shares being called away before expiration).
Potential Outcomes at Expiration:
Stock Price Below Strike Price (Out-of-the-Money):
Outcome: The call option expires worthless. You keep the entire premium and your shares.
Action: No action required. You can then sell another covered call. This is often the desired outcome if you want to keep the stock and generate recurring income.
Stock Price Above Strike Price (In-the-Money):
Outcome: The call option will likely be assigned. This means your shares will be sold at the strike price. You keep the premium and realize the profit from selling the shares at the strike price (minus your original cost basis).
Action: E*TRADE will automatically handle the assignment. You'll see your shares disappear from your account, and cash equivalent to the strike price will be credited.
Adjusting and Closing Your Covered Call Early:
You don't have to wait until expiration. Sometimes, it makes sense to close or adjust your position early.
Buying Back the Call (Buy to Close):
If the option's value has significantly decreased (e.g., stock price dropped, or a lot of time decay has occurred), you can "buy to close" the option. This means you buy back the same option you sold.
Your profit is the initial premium received minus the cost to buy it back. This allows you to lock in profits and free up your shares to either sell them outright or write a new covered call.
On ETRADE:* Go to your "Positions" tab, find your short call option, and select "Close" or "Buy to Close."
Rolling the Covered Call:
If the stock is approaching your strike price and you don't want to sell your shares, or if you want to extend the trade for more premium, you can "roll" the option.
This involves two simultaneous actions:
"Buy to Close" your current covered call.
"Sell to Open" a new covered call with a later expiration date and/or a different strike price (usually higher).
On ETRADE:* Many platforms, including Power E*TRADE, offer a "Roll" function within the options chain or positions tab, which can simplify this two-part transaction into one order.
Step 5: Understanding Risks and Managing Your Covered Calls Like a Pro
While covered calls are considered a relatively conservative options strategy, they are not without risks. Being aware of them and having a plan is crucial.
Key Risks:
Limited Upside Profit: As mentioned, if the stock surges, your profit is capped at the strike price plus the premium. You miss out on further appreciation.
Stock Price Decline: If the stock price falls significantly, the premium received will only partially offset your losses from the declining stock value. You still bear the full downside risk of owning the stock.
Opportunity Cost: If you write covered calls on a stock that subsequently rallies significantly, you might miss out on substantial gains you would have otherwise realized by simply holding the stock.
Early Assignment: While rare, an option can be assigned before expiration, especially if it's deep in-the-money and approaching an ex-dividend date. E*TRADE will notify you if this occurs, and your shares will be called away.
Transaction Costs: While E*TRADE often has $0 commissions for online US-listed options trades (with a per-contract fee), remember that commissions and fees still apply. These can eat into your profits, especially for smaller trades or frequent rolling.
Best Practices for Covered Calls:
Start Small: Begin with a small number of contracts and stocks you know well.
Choose Liquid Options: Stick to options with tight bid-ask spreads and good volume to ensure smooth entry and exit.
Set Realistic Expectations: Covered calls are an income-generating strategy, not a get-rich-quick scheme.
Have an Exit Strategy: Know when you'll buy back the option for a profit, when you'll roll it, and when you'll let it expire or get assigned.
Monitor Your Positions Regularly: Don't just set it and forget it. Market conditions can change rapidly.
Understand Tax Implications: Premiums received from covered calls are generally considered short-term capital gains if the option expires worthless or is closed for a gain, regardless of your holding period for the stock. If assigned, the premium increases your effective selling price. Consult a tax professional for personalized advice.
Frequently Asked Questions (FAQ)
How to calculate the breakeven point for a covered call?
The breakeven point for a covered call is calculated as: Stock Purchase Price - Premium Received. For example, if you bought stock at $100 and received $2 for selling a call, your breakeven is $98.
How to calculate the maximum profit of a covered call?
The maximum profit is calculated as: (Strike Price - Stock Purchase Price) + Premium Received. If your stock was bought at $100, you sell the $105 call for $2, your maximum profit is ($105 - $100) + $2 = $7 per share ($700 per contract).
How to close a covered call position on E*TRADE?
To close a covered call on E*TRADE, navigate to your "Positions" tab, locate the short call option, and select "Buy to Close." You will then place an order to buy back the exact same option contract you sold.
How to roll a covered call on E*TRADE?
To roll a covered call, you'll perform a two-part transaction: "Buy to Close" your existing short call and simultaneously "Sell to Open" a new call with a different strike price and/or expiration date. ETRADE's Power ETRADE platform often has a dedicated "Roll" feature that streamlines this process.
How to handle covered calls that are about to expire in-the-money on E*TRADE?
If your covered call is in-the-money near expiration and you don't want your shares to be called away, you must "Buy to Close" the option before market close on the expiration day. If you are comfortable selling your shares, you can simply let it expire and your shares will be automatically called away.
How to receive dividends when holding a covered call?
You will still receive dividends on your shares as long as you own the shares on the ex-dividend date. However, be mindful that if your covered call is deep in-the-money, there's an increased risk of early assignment right before the ex-dividend date, as the option buyer might exercise to capture the dividend.
How to choose the best expiration date for a covered call?
The best expiration date depends on your goals. Shorter-term options (1-4 weeks) offer faster time decay and more frequent premium collection but require more active management. Mid-term options (1-3 months) offer a good balance. Avoid very long-term options for income generation as their time decay is slower.
How to avoid early assignment with covered calls on E*TRADE?
The primary way to avoid early assignment is to "Buy to Close" your covered call before it becomes too deep in-the-money, especially around ex-dividend dates. If the option has little or no extrinsic value and is ITM, early assignment is more likely.
How to manage losses in a covered call strategy?
If the underlying stock falls significantly, the premium received will only partially offset the loss. To manage this, you might:
Do nothing: If you're long-term bullish on the stock, hold it, and potentially sell another covered call once the current one expires worthless.
Close the position: Buy back the call to realize the profit on the option (if any) and then decide whether to hold or sell the stock.
Roll down the strike: Sell a new call with a lower strike price (and possibly a later expiration) to collect more premium and further reduce your cost basis, though this implies a lower potential selling price for your stock.
How to qualify for options trading on E*TRADE?
To trade options on ETRADE (and most brokers), you typically need to apply for options trading privileges. This usually involves answering questions about your investing experience, financial situation, and risk tolerance. ETRADE has different options approval levels; covered calls generally fall under Level 1 or Level 2. You'll need to be approved for at least Level 1.
