Have you ever looked at your long-term stock holdings and thought, "How can I make these work harder for me?" If so, you're in the right place! Covered calls are an excellent options strategy that allows you to generate income from stocks you already own, even if the market is relatively flat. It's like getting paid a little extra rent on your investment property. Charles Schwab offers a robust platform for executing these trades, and we're going to walk through it step-by-step.
Before we dive in, remember that while covered calls are considered a more conservative options strategy, they still involve risk. You'll need to understand the potential outcomes and ensure your account is approved for options trading.
Demystifying Covered Calls: What Are They?
At its core, a covered call involves two components:
- You own at least 100 shares of a particular stock. This is the "covered" part, meaning you have the underlying asset to fulfill your obligation if the option is exercised.
- You sell (or "write") a call option contract on those shares. This contract gives the buyer the right, but not the obligation, to purchase your 100 shares at a specific price (the "strike price") on or before a certain date (the "expiration date").
In exchange for selling this right, you receive a premium, which is immediately credited to your account. This premium is your income.
Why would someone buy this right from you? They believe the stock price will rise above the strike price before expiration, allowing them to buy your shares at a discount.
What's in it for you? You generate income, especially in sideways or slightly bullish markets. However, your upside profit potential is limited to the strike price plus the premium received. If the stock soars past the strike price, you'll still sell your shares at the strike price, missing out on further gains.
Step 1: Ensure You're Approved for Options Trading on Charles Schwab
Before you even think about placing a trade, you need to make sure your Charles Schwab account is approved for options trading. This isn't an automatic feature for all brokerage accounts due to the inherent risks involved.
Sub-heading: Checking Your Current Approval Level
- Log in to your Charles Schwab account.
- Navigate to the "Profile" section. You'll typically find this by clicking on your name or a profile icon in the top right corner.
- Look for "Margin & Options" or a similar link.
- Here, you'll see your current options approval level. For covered calls, you generally need at least Level 0 options approval. This level specifically permits covered calls, covered puts, buy-writes, and similar "covered" strategies.
Sub-heading: Applying for Options Approval (If Needed)
If you're not approved or need a higher level:
- From the "Margin & Options" section, you should see an option to "Apply for Options" or "Upgrade Options Level."
- You'll be guided through an online application process. This will typically ask questions about your:
- Investment experience
- Financial situation (income, net worth)
- Investment objectives
- Risk tolerance
- Be truthful and thorough. Your responses will determine the options level you're approved for.
- You'll also need to read and consent to various agreements, including the "Characteristics and Risks of Standardized Options" disclosure document. This document is crucial to understanding the full scope of options trading risks.
- After submitting, Charles Schwab will review your application. You'll typically receive an email with the status of your request within a few business days.
Step 2: Identify a Suitable Stock for a Covered Call
Now that your account is ready, it's time to find the right stock. Remember, for a covered call, you must already own at least 100 shares of the underlying stock for each option contract you plan to sell.
Sub-heading: Characteristics of a Good Covered Call Candidate
- Stocks you're comfortable owning long-term: If the option expires worthless, you'll still own the shares. Choose a company you believe in.
- Stocks with relatively stable or slightly bullish outlooks: Covered calls perform best when the stock price stays below or slightly above your chosen strike price. Avoid highly volatile stocks where large price swings could lead to early assignment or significant missed upside.
- Stocks with sufficient options liquidity: You want options that are actively traded, meaning there's a narrow bid-ask spread and decent volume. This ensures you can easily enter and exit your position.
- Stocks with a history of paying dividends (optional): If you're holding for the long term, combining covered calls with dividend-paying stocks can further enhance your income.
Sub-heading: Using Charles Schwab's Tools to Screen for Opportunities
Charles Schwab offers powerful tools to help you identify potential covered call candidates.
- Log in to your Charles Schwab account.
- Navigate to the "Trade" tab.
- Look for "Options" or "Options Tools." You might find a dedicated "Options Screener" or similar functionality within the platform (e.g., on Schwab.com or Thinkorswim).
- Set your criteria:
- You can filter for stocks you already own.
- Specify your desired expiration timeframe (e.g., 30-60 days out).
- Look for options with decent open interest and volume to ensure liquidity.
- You might also screen for a specific "Delta," which can give you a rough probability of the option expiring in-the-money (e.g., a 0.25 delta suggests a 25% chance of being in-the-money at expiration).
Step 3: Select Your Covered Call Parameters
Once you've identified a stock, you need to choose the specific call option to sell. This involves deciding on the strike price and the expiration date.
Sub-heading: Understanding Strike Price and Expiration Date
- Strike Price: This is the price at which the option buyer can purchase your shares.
- In-the-Money (ITM) Strike: Below the current stock price. Selling an ITM call gives you a higher premium but a greater chance of assignment and less potential for stock price appreciation.
- At-the-Money (ATM) Strike: Roughly equal to the current stock price. Offers a good balance of premium and potential for the option to expire worthless.
- Out-of-the-Money (OTM) Strike: Above the current stock price. Gives you a lower premium but a lower chance of assignment and more room for the stock to appreciate before you'd be obligated to sell. Many covered call writers prefer OTM strikes to retain more upside potential.
- Expiration Date: This is the last day the option can be exercised.
- Shorter-term expirations (e.g., 1-3 months) typically offer less premium but allow you to re-evaluate your position more frequently.
- Longer-term expirations (e.g., 3-6 months or LEAPS) offer more premium but tie up your shares for a longer period and reduce your flexibility.
Sub-heading: Accessing the Options Chain on Charles Schwab
- From the "Trade" tab, enter the ticker symbol of the stock you own.
- Select "Options" as the trade type, or look for the "Options Chain."
- The options chain will display a list of available call and put options for various strike prices and expiration dates.
- Focus on the "Calls" side of the chain.
- Look at the Bid and Ask prices, Volume, and Open Interest for each strike and expiration. You want good liquidity (narrow bid-ask spreads, high volume/open interest).
- Consider the premium you'll receive (the "Bid" price). This is the cash you'll get for selling the option.
- Think about your outlook on the stock. If you expect it to stay relatively flat or rise only slightly, an OTM strike might be preferable. If you're looking for maximum income and don't mind selling your shares, an ATM or slightly ITM strike could be considered.
Step 4: Placing the Covered Call Trade on Charles Schwab
This is where you execute the actual trade. Charles Schwab's "All-In-One Trade Ticket" is a common way to do this.
Sub-heading: Using the All-In-One Trade Ticket
- On the "Trade" tab, select "All-In-One Trade Ticket."
- Enter the symbol of the stock you own.
- Under "Strategy," select "Call."
- The system should automatically detect that you own the shares and suggest a "Covered Call" strategy. If not, explicitly choose "Covered Call" or "Sell to Open Call."
- Specify the number of contracts you want to sell. Remember, one option contract typically represents 100 shares. So, if you own 500 shares, you can sell up to 5 contracts.
- Select the "Expiration Date" and "Strike Price" you decided on in Step 3.
- Choose your "Order Type."
- Limit Order: Highly recommended. This allows you to specify the exact premium (price) you want to receive. Your order will only execute if that price (or better) is available.
- Market Order: Generally not recommended for options as you could get an unfavorable fill, especially on less liquid options.
- Review the order details carefully:
- Underlying stock and shares
- Option type (Call)
- Action (Sell to Open)
- Expiration date
- Strike price
- Number of contracts
- Premium to be received (estimated)
- Commissions and fees
- Click "Review Order" or "Place Order."
- Confirm the order.
Sub-heading: What Happens After You Place the Trade
- Premium Received: The premium you agreed upon will be credited to your account almost immediately. This is your profit if the option expires worthless.
- Holding the Position: You now hold your shares of stock and have a short call option position.
- Monitoring the Stock: Keep an eye on the underlying stock's price.
Step 5: Managing Your Covered Call Position
A covered call isn't a "set it and forget it" strategy. You'll need to monitor the stock and the option as the expiration date approaches.
Sub-heading: Possible Scenarios at Expiration
- Stock Price is Below the Strike Price: This is generally the ideal outcome for income generation. The call option will expire worthless. You keep the entire premium, and you still own your 100 shares of stock. You are then free to sell another covered call on the same shares.
- Stock Price is Above the Strike Price:
- The option is "in-the-money." It's highly likely the option buyer will "exercise" their right to buy your shares.
- Your shares will be "called away." This means your 100 shares will be sold at the strike price. Your maximum profit is limited to the difference between your purchase price of the stock and the strike price, plus the premium received. While you might miss out on further upside beyond the strike, you still made a profit.
- Stock Price is Significantly Below Your Purchase Price: While the option will likely expire worthless (and you keep the premium), your long stock position will have lost value. The premium provides a small cushion, but it doesn't fully protect against a large drop in the stock's price.
Sub-heading: Adjusting Your Position (Rolling)
Sometimes, you might want to adjust your covered call before expiration. This is known as "rolling" the option.
- Rolling Up: If the stock price is rising and nearing your strike price, you might buy back your current call (closing it) and sell a new call with a higher strike price and/or a later expiration date. This allows you to capture more potential upside on your stock while still collecting a premium.
- Rolling Down: If the stock price has dropped significantly, you might buy back your current call and sell a new call with a lower strike price and/or a later expiration date. This can bring in more premium to offset some of the stock's loss or give you more time for the stock to recover.
- Rolling Out: If the stock price is near your strike and you don't want your shares called away, you can buy back your current call and sell a new call with the same strike price but a later expiration date. This gives the stock more time to move below the strike or allows you to collect another premium.
To roll a position, you'll generally place a "Buy to Close" order on your existing short call, and then a "Sell to Open" order on the new call. Charles Schwab's platform often has specific "Roll Option" functions to simplify this process into a single transaction.
Step 6: Understanding Tax Implications
It's crucial to understand the tax implications of covered calls. The premium you receive is generally considered short-term capital gains, even if you hold the underlying stock for a long time, unless it qualifies as a "Qualified Covered Call" (QCC) under IRS rules. QCCs have specific criteria (e.g., expiration date greater than 30 days, not "deep-in-the-money"). Consult a tax advisor for personalized guidance.
Final Considerations
- Commissions and Fees: Remember that each options trade (opening and closing) incurs commissions and per-contract fees. Factor these into your profit calculations.
- Early Assignment: While less common for out-of-the-money calls, an option can be assigned early, especially if there's an upcoming dividend payment and the option is in-the-money. Be prepared for your shares to be called away at any time.
- Risk Management: While covered calls limit upside, they do not fully protect against downside risk in your underlying stock. The premium received merely acts as a small buffer.
By following these steps and understanding the nuances of covered calls, you can leverage your Charles Schwab account to generate additional income from your stock portfolio.
10 Related FAQ Questions
How to check my options approval level on Charles Schwab?
You can check your options approval level by logging into your Charles Schwab account, navigating to "Profile," and then looking for the "Margin & Options" section. Your current level will be displayed there.
How to apply for higher options trading approval on Charles Schwab?
To apply for a higher options trading approval level, go to the "Margin & Options" section within your Charles Schwab profile and select "Apply for Options" or "Upgrade Options Level." You'll complete an online application detailing your experience and financial situation.
How to find suitable stocks for covered calls on Charles Schwab?
You can find suitable stocks by logging into your Schwab account, going to the "Trade" tab, and using the "Options" or "Options Tools" section, specifically the "Options Screener," to filter for stocks you own with good options liquidity and a stable or slightly bullish outlook.
How to select the right strike price for a covered call?
Select a strike price that aligns with your outlook on the stock. Out-of-the-money (OTM) strikes (above the current stock price) are often preferred for income generation as they offer more room for stock appreciation and a lower chance of assignment, though they yield less premium.
How to choose the best expiration date for a covered call?
The best expiration date depends on your strategy. Shorter-term expirations (1-3 months) offer less premium but more flexibility, while longer-term expirations (3-6 months) yield higher premiums but tie up your shares longer.
How to place a covered call order on Charles Schwab's platform?
Log in to Schwab, go to "Trade," then "All-In-One Trade Ticket." Enter the stock symbol, select "Call" as the strategy, specify the number of contracts, choose the expiration and strike price, set a "Limit Order" for your desired premium, review, and place the order.
How to interpret the premium received from a covered call?
The premium you receive is the cash payment for selling the option. It's immediately credited to your account and represents the maximum profit from the option component of your trade if the option expires worthless.
How to manage a covered call if the stock price moves?
If the stock price moves significantly, you can "roll" the option. Rolling involves buying back your existing call and selling a new one with a different strike price and/or expiration date to adjust your position, capture more upside, or collect additional premium.
How to avoid early assignment on a covered call?
While you can't guarantee avoiding early assignment, it's less common for out-of-the-money calls. If an in-the-money call is nearing expiration or an ex-dividend date, early assignment becomes more likely. You can "buy to close" the option to avoid assignment if you wish to retain your shares.
How to understand the tax implications of covered calls?
Generally, the premium from selling covered calls is considered a short-term capital gain unless the option qualifies as a "Qualified Covered Call" (QCC) under IRS rules. It's always best to consult with a qualified tax advisor for personalized advice on your specific situation.