You're ready to take your investing to the next level by exploring options, and specifically, the covered call strategy on Charles Schwab. Excellent choice! Covered calls can be a fantastic way to potentially generate income from stocks you already own, adding a layer of sophistication to your portfolio management. However, like all investment strategies, it's crucial to understand the nuances and potential risks involved. This comprehensive guide will walk you through everything you need to know to confidently place a covered call on Charles Schwab, step-by-step.
Understanding the Covered Call Strategy
Before we dive into the "how-to," let's quickly recap what a covered call is. A covered call involves selling a call option on a stock you already own. For each standard option contract, you need to own 100 shares of the underlying stock.
- You, as the seller (or "writer") of the call option, receive a premium (a payment) from the buyer.
- In exchange for this premium, you grant the buyer the right, but not the obligation, to purchase your shares at a specified price (the "strike price") on or before a certain date (the "expiration date").
Why do investors use covered calls?
- Income Generation: The primary reason is to generate additional income from your existing stock holdings, especially if you expect the stock to trade sideways or experience only a modest increase in price.
- Limited Downside Protection: The premium received offers a small buffer against a decline in the stock's price.
- Neutral to Bullish Outlook: This strategy is generally used when you have a neutral to slightly bullish outlook on the underlying stock. You don't expect a massive surge in price, but you're comfortable holding the stock if it doesn't get called away.
What are the key considerations?
- Limited Upside Potential: If the stock price skyrockets above your strike price, you will be obligated to sell your shares at that lower strike price, capping your potential profit on the stock itself. You miss out on further gains above the strike price.
- Obligation to Sell: If the option expires "in-the-money" (meaning the stock price is above the strike price), your shares will likely be "called away" (sold) at the strike price.
- Early Assignment Risk: While less common, your shares can be called away before the expiration date, particularly if the stock goes significantly in-the-money or an ex-dividend date approaches.
Now that we're on the same page about what a covered call entails, let's get into the practical steps of placing one on Charles Schwab.
Tip: Look for small cues in wording.
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| How To Place A Covered Call On Charles Schwab |
Step 1: Ensure Your Charles Schwab Account is Options-Approved
Before you can even think about placing a covered call, you need to make sure your Charles Schwab account is approved for options trading. This is a non-negotiable first step. Charles Schwab, like all brokers, has different options approval levels based on your financial situation, trading experience, and risk tolerance.
Sub-heading: Checking Your Current Approval Level
- Log in to your Charles Schwab account on their website.
- Navigate to your account settings or profile. Look for sections related to "Trading," "Options," or "Account Features."
- You should be able to see your current options trading approval level. For covered calls, you typically need at least Level 0 options approval.
Sub-heading: Applying for or Upgrading Options Approval
If you're not approved or need to upgrade your level:
- Look for an option to "Apply for Options Trading" or "Upgrade Options Level" within the same account settings area.
- You will likely be asked to complete an Options Trading Application. This application will ask questions about your financial status (income, net worth), investment experience, and your understanding of options risks.
- Be honest and thorough in your responses. Misrepresenting information can lead to issues later.
- Once submitted, Charles Schwab will review your application. This process can take a few business days. You'll receive a confirmation once your application is approved and your new options trading level is assigned.
Step 2: Identify the Underlying Stock
A covered call, by definition, requires you to own the underlying shares. You can't sell a covered call unless you have at least 100 shares of the stock for every option contract you plan to sell.
Sub-heading: Choosing the Right Stock for a Covered Call
- Stocks you already own: This is the most common scenario. You're looking to generate extra income from a stock you're holding long-term.
- Stocks you're comfortable selling: Even though you're selling a call, there's always the chance your shares will be called away. Only write covered calls on stocks you wouldn't mind selling at the strike price.
- Stocks with moderate volatility: Extremely volatile stocks might lead to early assignment or situations where you miss out on significant upside. Stocks that tend to trade in a range or have a slight upward trend are often good candidates.
- Stocks with sufficient liquidity: For options, liquidity is key. Look for stocks with active options markets to ensure you can easily enter and exit positions.
Example: Let's say you own 200 shares of XYZ Corp. (XYZ), currently trading at $50 per share, and you've held it for a while. You believe XYZ might hover around $50-$55 for the next month or two, and you want to generate some extra income. This makes XYZ a good candidate for a covered call.
Tip: Read at your natural pace.
Step 3: Navigate to the Trade Ticket on Charles Schwab
Once you're logged in and have chosen your stock, it's time to find the options trading interface.
- From the Charles Schwab homepage, look for the "Trade" menu option.
- Under the "Trade" menu, select "All-In-One Trade Ticket." This is Schwab's versatile order entry system that handles various trade types, including options.
Step 4: Configure Your Covered Call Order
This is where you'll input the specifics of your covered call. The "All-In-One Trade Ticket" is designed to be intuitive, but let's break down each important field.
Sub-heading: Entering the Security Symbol and Strategy
- Symbol: Enter the ticker symbol of the stock you own (e.g., XYZ).
- Strategy: This is crucial. From the "Strategy" dropdown menu, select "Call."
- Note: If you don't own the stock yet and want to buy the stock and sell the call in one combined order (a "Buy Write"), you would select "Buy Write" as the strategy. This guide focuses on covered calls where you already own the shares.
Sub-heading: Defining the Action, Quantity, and Expiration
- Action: For a covered call, you are selling an option to open a new position. Therefore, select "Sell to Open."
- Quantity: Specify the number of option contracts you want to sell. Remember, one option contract typically represents 100 shares of the underlying stock. So, if you own 200 shares of XYZ, you can sell up to 2 contracts. If you sell more contracts than shares you own, it becomes a "naked call," which is far riskier and requires a higher options approval level. Stick to the number of contracts your owned shares can cover.
- Expiration: This is the date the option contract expires. Options are typically available with weekly or monthly expiration dates.
- Consider your outlook: If you expect the stock to stay within a range for a shorter period, a nearer-term expiration might be suitable for more frequent income generation. For a longer-term outlook, you might choose a further-out expiration.
- Click on the desired expiration date from the displayed options chain.
Sub-heading: Choosing the Strike Price
The strike price is the price at which the option buyer can purchase your shares.
- After selecting the expiration date, the options chain will display various strike prices.
- Select a strike price that aligns with your investment goals.
- Out-of-the-Money (OTM) Calls: These have strike prices above the current market price of the stock. They offer less premium but a higher chance of the option expiring worthless (allowing you to keep the premium and your shares). This is the most common approach for covered calls.
- At-the-Money (ATM) Calls: These have strike prices equal to or very close to the current market price. They offer more premium but a higher probability of being exercised, meaning your shares will likely be called away.
- In-the-Money (ITM) Calls: These have strike prices below the current market price. They offer the most premium but are almost guaranteed to be exercised, and you'll sell your shares at a lower price than the current market value. This is typically used when you're looking to sell your shares at a specific price in the near future.
- For most income-generating covered calls, aim for an out-of-the-money strike price.
Sub-heading: Setting the Order Type and Price
- Order Type:
- Limit Order (Recommended): This allows you to specify the exact price (premium) you want to receive for selling the option. Your order will only execute if the market price reaches your specified limit or better. This gives you control over the premium received.
- Market Order: This executes your order immediately at the best available market price. While quick, you might receive a less favorable premium, especially for less liquid options. Generally, avoid market orders for options.
- Price (for Limit Orders): Enter the premium per share you wish to receive. This will be displayed as a dollar amount (e.g., $1.50). Remember that one contract represents 100 shares, so a $1.50 premium per share translates to $150 per contract.
- The trade ticket will often show the current bid and ask prices. The bid is what buyers are currently willing to pay, and the ask is what sellers are asking. You'll typically want to place your limit order somewhere between the bid and ask, or at the bid if you want a faster fill.
Sub-heading: Specifying the Timing (Time-in-Force)
- Time-in-Force (TIF): This dictates how long your order remains active.
- Day: The order is active only for the current trading day and cancels if not filled.
- Good 'Til Canceled (GTC): The order remains active until it's filled or you manually cancel it (typically up to 60 calendar days on Schwab).
- Other options like "Fill or Kill" (FOK) or "Immediate or Cancel" (IOC) are generally less common for covered calls for beginners.
- For most covered calls, "Day" or "GTC" are common choices depending on how aggressive you want to be.
Step 5: Review and Place Your Order
This is a critical step to ensure accuracy and prevent costly errors.
QuickTip: Scroll back if you lose track.
- After filling out all the details, click the "Review Order" button.
- A confirmation screen will appear, summarizing all the details of your order:
- Action: Sell to Open
- Quantity of contracts
- Underlying symbol
- Expiration date
- Strike price
- Order type (Limit/Market)
- Limit price (if applicable)
- Estimated premium to be received
- Commissions and fees
- Any warnings or messages (e.g., "option is far out-of-the-money")
- Carefully scrutinize every detail. Double-check the strike price and expiration date to ensure they match your intentions.
- If everything looks correct and you are comfortable with the trade, click "Place Order."
Step 6: Monitor Your Covered Call Position
Once your order is placed and potentially filled, your covered call position will appear in your Charles Schwab account. Now the monitoring begins!
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Sub-heading: Understanding the Outcomes
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Scenario 1: Option Expires Worthless (Stock Price Below Strike Price)
- This is the ideal outcome if your primary goal is income generation and you want to keep your shares.
- If, at expiration, the stock price is below your strike price, the call option will expire worthless.
- You keep the entire premium you received, and you continue to own your 100 shares of XYZ. Congratulations, you've successfully generated income!
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Scenario 2: Option is Exercised (Stock Price Above Strike Price)
- If, at expiration, the stock price is above your strike price, the call option will likely be exercised.
- This means you are obligated to sell your 100 shares of XYZ at the strike price to the option buyer.
- You keep the premium received, but your upside profit on the stock is capped at the strike price plus the premium.
Sub-heading: Managing Your Position Before Expiration
You don't have to wait until expiration. You can manage your covered call in a few ways:
- Buy to Close: If the option's value decreases significantly (e.g., the stock price drops, or time decay sets in), you can "buy to close" your call option. This effectively cancels your obligation, and you get to keep the difference between the premium you received and the cost to buy it back. This is often done to lock in a profit or to prevent your shares from being called away if you change your mind about selling them.
- To do this on Schwab: Go to your "Positions" tab, find the call option you sold, and there should be an option to "Close Position" or "Buy to Close." This will pre-populate a trade ticket for you.
- Roll the Option: If your option is nearing expiration and the stock price is close to the strike, you might consider "rolling" the option. This involves:
- Buying to close your current call option.
- Selling to open a new call option with a later expiration date and/or a different strike price.
- Rolling can allow you to extend your income generation, potentially adjust your strike price, or avoid assignment. Schwab's trade ticket often has a "Roll Position" option directly from your positions tab.
Frequently Asked Questions (FAQs)
How to get approved for options trading on Charles Schwab?
You need to apply for options trading approval through your Charles Schwab account online. Navigate to "Account Services" or "Profile" and look for "Options Trading." You'll complete an application assessing your financial information and trading experience.
How to find the "All-In-One Trade Ticket" on Charles Schwab?
After logging in to Schwab.com, click on the "Trade" menu at the top of the page, and then select "All-In-One Trade Ticket" from the dropdown.
QuickTip: Compare this post with what you already know.
How to select the right strike price for a covered call?
Consider your outlook on the stock. For income generation and to keep your shares, choose an out-of-the-money strike price (above the current market price). If you're willing to sell your shares and want more premium, you might consider an at-the-money strike.
How to understand the premium received from a covered call?
The premium is the income you receive for selling the option. It's quoted per share, so multiply the premium by 100 to get the total amount received per contract (before commissions).
How to determine the expiration date for a covered call?
Choose an expiration date that aligns with your short-term outlook on the stock. Shorter-term options (weekly or monthly) offer quicker income cycles but require more frequent management. Longer-term options generally provide more premium but tie up your shares for longer.
How to close a covered call position on Charles Schwab?
Go to your "Positions" tab, locate the call option you sold, and select "Close Position" or "Buy to Close." This will populate a new trade ticket for you to submit a "Buy to Close" order.
How to roll a covered call on Charles Schwab?
From your "Positions" tab, find the call option you wish to roll and select "Roll Position." This will guide you through closing your current option and opening a new one with different strike and/or expiration dates.
How to avoid early assignment on a covered call?
While not guaranteed, early assignment is less likely if the option is out-of-the-money. If the option becomes deeply in-the-money, you might consider buying to close or rolling the option to avoid early assignment, especially around ex-dividend dates.
How to calculate the maximum profit and loss of a covered call?
- Maximum Profit: (Strike Price - Stock Purchase Price) + Premium Received
- Maximum Loss: Stock Purchase Price - Premium Received (if the stock goes to zero)
How to learn more about options trading on Charles Schwab?
Charles Schwab offers extensive educational resources, including articles, videos, and live webcasts on options trading strategies. Look for their "Education" or "Learn" sections on their website, specifically within the "Options" category.
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