Do you own shares of a company you believe in, but you're not expecting it to skyrocket in price in the immediate future? Or perhaps you're looking for a way to generate some extra income from your existing portfolio? If so, then selling covered calls on Charles Schwab might be just the strategy for you! It's a fantastic way to earn a little extra cash while potentially lowering your cost basis on stocks you already hold. Ready to dive in? Let's get started!
What Exactly is a Covered Call?
Before we jump into the "how-to," let's clarify what a covered call is. Simply put, a covered call involves two components:
- You own 100 shares (or multiples of 100 shares) of an underlying stock. This is the "covered" part – your shares act as collateral.
- You sell (or "write") a call option contract on those same shares. A call option gives the buyer the right, but not the obligation, to purchase your 100 shares of stock 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 payment called a premium. This premium is yours to keep, regardless of what happens with the stock price.
Why would you do this? The idea is to generate income from your existing stock holdings, especially if you have a neutral to slightly bullish outlook on the stock's short-term price movement. If the stock price stays below the strike price at expiration, the option expires worthless, you keep the premium, and you still own your shares. If the stock price goes above the strike price, you're obligated to sell your shares at that strike price.
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| How To Sell Covered Calls On Charles Schwab |
Understanding the Risks and Rewards
Like any investment strategy, covered calls come with their own set of pros and cons. It's crucial to understand these before you begin.
Benefits of Selling Covered Calls:
- Income Generation: This is the primary benefit. The premium you receive provides immediate income, enhancing your overall return on the stock.
- Reduced Cost Basis: The premium collected effectively lowers the price you "paid" for your shares, providing a small buffer against potential price drops.
- Profit in Sideways Markets: If the stock trades sideways or experiences only modest gains, the option can expire worthless, and you keep the premium, outperforming simply holding the stock.
- Defined Risk (to a degree): Unlike selling "naked" calls (where you don't own the underlying stock and face potentially unlimited risk), your obligation is "covered" by your existing shares.
Risks of Selling Covered Calls:
- Limited Upside Potential: This is the biggest drawback. If the stock price skyrockets above your chosen strike price, your profit is capped at the strike price plus the premium received. You miss out on any gains beyond that point.
- Stock Ownership Risk: While the premium offers a small cushion, you are still exposed to the downside risk of owning the stock. If the stock price plummets, your losses can be substantial, exceeding the premium received.
- Opportunity Cost: If the stock takes off, you might feel regret for having sold it at the strike price, missing out on potentially significant capital appreciation.
- Early Assignment: While less common for out-of-the-money calls, an option can be exercised early, especially if the stock goes ex-dividend while trading above the strike price. This could lead to an unexpected sale of your shares.
- Transaction Costs: Remember to account for commissions and fees on both the selling and potentially the buying back of options.
Step 1: Getting Your Charles Schwab Account Ready
Alright, let's get hands-on! The very first thing you need to do is ensure your Charles Schwab account is enabled for options trading, specifically for selling covered calls.
A. Assess Your Eligibility:
Charles Schwab, like all brokers, has certain requirements for options trading due to the inherent risks. You'll need to have an options trading approval level that permits selling covered calls. This typically involves:
Tip: Read the whole thing before forming an opinion.
- Sufficient Funds: You need enough capital to hold the underlying shares.
- Knowledge and Experience: Schwab will ask you questions about your investment experience and understanding of options.
- Risk Tolerance: You'll need to indicate that you understand and are comfortable with the risks associated with options.
Action Item: If you're unsure of your current options trading level, or if you haven't enabled options trading yet, log into your Charles Schwab account. Navigate to the "Service" or "Client Services" section. Look for "Account Features," "Options Trading," or similar. You'll likely find an application or a way to check your current trading level. If you need to upgrade, follow the on-screen prompts or contact Schwab directly.
B. Fund Your Account (if necessary):
You must own at least 100 shares of the stock for each covered call contract you intend to sell. Make sure you have enough funds to purchase these shares if you don't already own them.
Step 2: Selecting the Right Stock for Your Covered Call
This is where your research and investment philosophy come into play. Choosing the right stock is paramount for a successful covered call strategy.
A. Look for Stocks You Already Own and are Comfortable Holding:
The ideal candidate for a covered call is a stock you:
- Are bullish on for the long term, even if you anticipate short-term stagnation or a modest rise.
- Are comfortable selling at the strike price if the option gets exercised. Don't sell covered calls on stocks you absolutely do not want to part with.
- ***Have at least 100 shares of (or multiples of 100)***. Each option contract controls 100 shares.
B. Consider the Stock's Volatility:
- Low to Moderate Volatility is Preferred: Highly volatile stocks can make covered calls riskier. If the stock unexpectedly surges, you'll miss out on significant gains. If it plummets, the premium might not sufficiently offset your losses.
- Look for Stocks with Liquid Options: Ensure there's enough trading volume in the options contracts for the stock you're considering. Thinly traded options can lead to wide bid-ask spreads, making it harder to get a good price when selling or buying back.
C. Analyze the Stock's Price Action:
- Neutral to Slightly Bullish Outlook: This strategy performs best when you expect the stock to trade sideways or rise modestly.
- Avoid Stocks You Expect to Plummet: While the premium provides a small buffer, it won't protect you from a significant downturn.
- Consider Dividend Stocks (Carefully): If you sell a covered call on a dividend stock, be aware that if the option goes in-the-money and approaches expiration, the buyer might exercise early to capture the dividend. This means your shares could be called away before the ex-dividend date, and you'd miss the dividend payment.
Step 3: Choosing the Right Strike Price and Expiration Date
These two elements are critical and directly impact your potential profit and risk.
QuickTip: Note key words you want to remember.
A. Selecting the Strike Price:
The strike price is the price at which you agree to sell your shares if the option is exercised.
- Out-of-the-Money (OTM): This means the strike price is above the current market price of the stock.
- Pros: Allows for some capital appreciation in the stock before assignment. Lower probability of assignment, meaning you're more likely to keep your shares and the premium.
- Cons: Typically offers a lower premium.
- At-the-Money (ATM): The strike price is equal to or very close to the current market price.
- Pros: Offers a higher premium.
- Cons: Higher probability of assignment, meaning your shares are more likely to be called away, limiting your upside.
- In-the-Money (ITM): The strike price is below the current market price.
- Pros: Offers the highest premium, providing more downside protection.
- Cons: Almost guaranteed assignment if the stock stays above the strike, meaning your shares will be sold, and you'll miss out on any current market value above the strike. This is often used when you are ready to sell your shares at a specific price anyway.
Consideration: Choose a strike price where you are comfortable selling your shares if the option is exercised. If you don't want to sell your stock, pick an OTM strike price with a low probability of being in the money.
B. Choosing the Expiration Date:
The expiration date determines how long the option contract is valid.
- Short-Term (e.g., 1 week to 1 month):
- Pros: Faster premium collection. You can write more covered calls throughout the year, potentially generating more income. Less time for the stock to make a huge move, reducing the chance of missing out on significant upside.
- Cons: Premiums are generally smaller per contract. More frequent trading activity required.
- Mid-Term (e.g., 1-3 months):
- Pros: Offers a balance between premium size and time horizon.
- Cons: Still requires attention and management.
- Long-Term (e.g., LEAPS or 3+ months):
- Pros: Larger premiums. Less frequent trading activity.
- Cons: Ties up your shares for a longer period. More time for the stock to move significantly, increasing the chance of missing out on large gains or experiencing greater downside.
Consideration: Beginners often start with shorter-term expirations (1-2 months) to gain experience and manage positions more actively. The goal is often to have the option expire worthless, allowing you to keep the premium and write another covered call.
Step 4: Placing the Covered Call Trade on Charles Schwab
Now for the practical part! This is how you'll execute the trade on the Charles Schwab platform. The process is generally similar whether you're using the website, the desktop platform (thinkorswim), or the mobile app. We'll focus on the general steps, as interface specifics can vary slightly.
A. Navigate to the Trading Platform:
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- Log in to your Charles Schwab account.
- Look for a "Trade" or "Trading" tab/menu.
- Select "All-In-One Trade Ticket" or a similar option for placing orders.
B. Enter the Stock Symbol:
Tip: Rest your eyes, then continue.
- In the "Symbol" field, enter the ticker symbol of the stock you own (e.g., AAPL for Apple).
- The system should automatically recognize that you hold shares.
C. Configure the Option Details:
- Strategy: Under "Strategy," select "Call" (since you're selling a call option).
- Action: This is crucial. Select "Sell to Open" (or "Sell Call") as your action. This indicates you are initiating a new short options position.
- Quantity: Enter the number of contracts you want to sell. Remember, each contract represents 100 shares. So, if you own 500 shares, you can sell up to 5 contracts.
- Expiration Date: Choose your desired expiration month from the dropdown menu.
- Strike Price: Select the specific strike price you've decided on.
D. Choose Your Order Type:
- Limit Order (Highly Recommended!): This allows you to specify the exact premium you want to receive for selling the option.
- Enter your desired "Limit Price" (the premium you want per share). Remember, the premium displayed is usually per share, so if it says $1.50, you'll receive $150 per contract (1.50 x 100 shares).
- This is generally the safest way to trade options as it ensures you get the price you want.
- Market Order (Generally NOT Recommended for Options): A market order will execute immediately at the best available price. While fast, the price can fluctuate rapidly, and you might receive a less-than-ideal premium.
- Time-in-Force:
- Day: The order will be active only for the current trading day. If it doesn't fill, it's canceled.
- Good-Til-Canceled (GTC): The order remains active until it's filled or you manually cancel it (typically up to 60 days).
E. Review and Confirm:
- Carefully review all the details of your order: stock symbol, action (Sell to Open), quantity, expiration, strike price, order type, and limit price.
- Look for the "Estimated Premium" or "Credit" that you will receive.
- Click "Review Order" or "Preview Order."
- If everything looks correct, confirm and place the order.
Congratulations! You've just placed your first covered call order on Charles Schwab!
Step 5: Monitoring and Managing Your Covered Call Position
Selling a covered call isn't a "set it and forget it" strategy. Active management is key to maximizing your returns and minimizing potential headaches.
A. Track the Stock Price:
- Keep an eye on the underlying stock's price movements relative to your strike price.
- If the stock is well below your strike price: The option is likely to expire worthless, and you'll keep the full premium.
- If the stock approaches or exceeds your strike price: Be prepared for potential assignment.
B. Monitor the Option's Value:
- The value of the option contract will change based on the underlying stock price, time decay, and implied volatility.
- Time Decay (Theta): As the expiration date approaches, the time value of the option erodes. This is generally favorable for you as the seller, as the option becomes less valuable and closer to expiring worthless.
- Implied Volatility: Higher implied volatility generally means higher option premiums. If volatility drops, so might the premium, which can be an opportunity to buy back the option for less.
C. Decide on Your Exit Strategy:
You generally have a few options as expiration approaches:
QuickTip: Skip distractions — focus on the words.
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Let the Option Expire Worthless:
- Scenario: The stock price is below your strike price at expiration.
- Action: Do nothing. The option expires worthless, you keep the full premium, and you still own your shares. This is often the desired outcome.
- Next Step: You can then choose to sell another covered call on the same shares for a future expiration date.
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Allow Assignment (Shares are Called Away):
- Scenario: The stock price is above your strike price at expiration.
- Action: Your shares will automatically be sold at the strike price. You'll receive cash for your shares, and you keep the premium you initially collected.
- Consideration: If you were happy to sell at that price, great! If not, this is where you might feel the "opportunity cost" of missing out on further upside.
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Buy Back the Option to Close the Position:
- Scenario: The stock price is moving unfavorably (e.g., skyrocketing past your strike, or plummeting, and you want to reduce downside risk), or you simply want to free up your shares.
- Action: Place a "Buy to Close" order for the same call option you sold. You'll pay the current market price of the option.
- When to do this:
- If the stock price has fallen significantly: You can buy back the option for a very low price (or it might be close to worthless) and then sell another covered call with a lower strike price or on a different stock. This locks in your original premium while potentially reducing your cost basis further.
- If the stock price has surged past your strike: If you decide you don't want your shares to be called away and believe the stock will continue to rise, you can buy back the call to avoid assignment. However, this means you'll pay a higher price than you received, reducing your overall profit or even resulting in a net loss on the options leg of the trade. You would only do this if you strongly believe the stock will continue to appreciate significantly.
- To "Roll" the Option: If the option is approaching expiration and is in-the-money, but you don't want to sell your shares, you can buy back the existing call and simultaneously sell a new call with a later expiration date and/or a higher strike price. This is known as "rolling" the option and can allow you to continue generating income while keeping your shares.
Advanced Considerations for Covered Calls
As you gain experience, you might want to explore some finer points of covered call management:
- Delta: This "Greek" measures how much an option's price is expected to move for every $1 change in the underlying stock price. A delta of 0.25 (or -0.25 for a short call) suggests a roughly 25% chance of the option expiring in-the-money. Many covered call writers aim for OTM calls with deltas between -0.20 and -0.30.
- Vega: Measures an option's sensitivity to changes in implied volatility. If you expect volatility to decrease, selling calls (which benefit from lower volatility) can be advantageous.
- Theta: As mentioned, this measures time decay. For options sellers, a positive theta means you benefit as time passes.
- Adjusting the Position: Don't be afraid to adjust your covered call if market conditions change. This could involve buying back the call, rolling it, or even selling another call if the existing one expires worthless.
Final Thoughts on Covered Calls
Selling covered calls on Charles Schwab is a solid strategy for income generation and can be a great way to put your existing stock holdings to work. It's particularly appealing for investors who are comfortable with the idea of potentially selling their shares at a predetermined price and are looking to enhance their returns in a flat or mildly bullish market. Start small, understand the mechanics, and always be prepared for the various outcomes. With practice, it can become a valuable tool in your investment arsenal.
10 Related FAQ Questions
How to get approved for options trading on Charles Schwab? You can apply for options trading approval by logging into your Charles Schwab account and navigating to the "Service" or "Client Services" section, then looking for "Account Features" or "Options Trading." You'll typically fill out an application about your investment experience and financial situation.
How to find suitable stocks for selling covered calls on Charles Schwab? On Charles Schwab, you can use their screening tools or research sections to find stocks you own that have liquid options. Look for companies you are comfortable holding long-term but don't expect dramatic short-term appreciation, and ensure they have adequate options volume.
How to determine the best strike price for a covered call? The best strike price depends on your outlook. For income and a higher chance of keeping shares, choose an out-of-the-money (OTM) strike (above the current stock price). For higher premium or if you're ready to sell, consider an at-the-money (ATM) or slightly in-the-money (ITM) strike.
How to select the ideal expiration date for a covered call? Shorter expiration dates (1-2 months) generally offer less premium but allow for more frequent premium collection and less time for the stock to make a significant move. Longer dates offer higher premiums but tie up your shares for longer.
How to calculate the potential profit from a covered call? Your maximum profit from a covered call is the premium received plus any capital appreciation of the stock up to the strike price (Strike Price - Stock Purchase Price + Premium Received).
How to close a covered call position on Charles Schwab? To close a covered call, you place a "Buy to Close" order for the same option contract you originally sold. This effectively buys back the option, canceling your obligation.
How to roll a covered call to a later expiration date? To roll a covered call, you simultaneously place a "Buy to Close" order for your existing short call and a "Sell to Open" order for a new call with a later expiration date (and usually a higher strike price) on the same underlying stock.
How to handle a covered call that goes in-the-money? If your covered call goes in-the-money, you have a few options: allow assignment (shares get sold at the strike price), buy back the option to close it (if you want to keep the shares and avoid assignment), or roll the option to a later date/higher strike.
How to avoid early assignment on a covered call? While not guaranteed, early assignment is less likely for out-of-the-money calls. It's more common around ex-dividend dates if the option is in-the-money. If you want to avoid early assignment, you might consider closing the position before the ex-dividend date or rolling it.
How to view your covered call positions on Charles Schwab? You can typically view your open covered call positions in your Charles Schwab account by navigating to your "Positions" or "Portfolio" tab, where they will be listed along with your stock holdings.
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