Income strategies involve selling options against stock positions. Here’s a video introduction:
A common income strategy is to go long stock and short a call options contract. This position is called a covered call because the investor already owns the shares needed to meet the call obligation.
For example:
Long 100 shares of ABC stock @ $54
Short 1 ABC Jan 55 call @ $4
Income strategies are typically used when you expect a relatively flat market. Suppose you bought ABC at $54 and the stock doesn’t move much. You can sell a call option against the shares to generate income.
Selling the call creates a clear trade-off:
If ABC rises above $55, the call goes in the money (it has intrinsic value) and may be exercised (the investor is “called away”). A short call obligates the writer to sell shares at the strike price. A naked short call can have very large risk because the shares might need to be purchased at a higher market price.
In a covered call, you already own the shares. If assigned, you deliver the shares you own instead of buying them in the market. That’s why the call risk is considered covered.
If ABC stays flat or falls, the call typically expires worthless. You keep the premium, but you still face downside risk from owning the stock. The further the stock falls, the larger the loss on the shares.
Let’s look at a few examples:
An investor buys 100 shares of ABC stock at $54 and goes short 1 ABC Jan 55 call at $4. What is the gain or loss if ABC’s market price rises to $70?
Can you figure it out?
Answer = $500 gain
| Action | Result |
|---|---|
| Buy shares | -$5,400 |
| Sell call | +$400 |
| Assigned - sell shares | +$5,500 |
| Total | +$500 |
This strategy is designed for a flat market, but here the stock rose sharply to $70. Because the call is in the money, the investor is assigned and must sell the shares at $55.
This is where opportunity cost shows up. Without the short call, the investor would have gained $1,600 on the stock (from $54 to $70, times 100 shares). By selling the call, the investor capped the upside and gave up any profit above $55.
This example highlights the main “risk” of the short call in a covered call: it limits upside. That’s an opportunity cost, not an additional loss beyond what owning the stock already creates. In fact, the call premium reduces downside risk slightly because it offsets stock losses dollar-for-dollar up to the premium amount.
Income strategies work best when prices don’t move much. Now consider a flat market.
An investor buys 100 shares of ABC stock at $54 and goes short 1 ABC Jan 55 call at $4. What is the gain or loss if ABC’s market price stays flat at $54?
Answer = $400 gain
| Action | Result |
|---|---|
| Buy shares | -$5,400 |
| Sell call | +$400 |
| Value of shares | +$5,400 |
| Total | +$400 |
The call stays out of the money and expires worthless. The shares don’t gain or lose value, and the investor keeps the $400 premium.
Without selling the call, the investor would have no gain or loss. This is the core benefit of an income strategy in a flat market: the option premium can create a return even when the stock doesn’t move.
What happens if ABC falls a little?
An investor buys 100 shares of ABC stock at $54 and goes short 1 ABC Jan 55 call at $4. What is the gain or loss if ABC’s market price falls to $50?
Answer = $0 (breakeven)
| Action | Result |
|---|---|
| Buy shares | -$5,400 |
| Sell call | +$400 |
| Value of shares | +$5,000 |
| Total | $0 |
The call remains out of the money and expires worthless. The stock loses $4 per share ($400 total), and the $400 premium offsets that loss.
This shows the “cushion” created by the premium: the stock can fall by up to the premium received before the overall position turns into a net loss.
For the last covered call example, consider a large market decline.
An investor buys 100 shares of ABC stock at $54 and goes short 1 ABC Jan 55 call at $4. What is the gain or loss if ABC’s market price falls to $30?
Answer = $2,000 loss
| Action | Result |
|---|---|
| Buy shares | -$5,400 |
| Sell call | +$400 |
| Value of shares | +$3,000 |
| Total | -$2,000 |
The call stays out of the money and expires worthless. The shares lose $2,400 in value ($24 × 100), but the investor keeps the $400 premium.
The option isn’t intended to be a hedge, but it does act as a partial hedge. Without the call premium, the loss would have been $2,400. The premium reduces the loss to $2,000.
Watch this video if you need additional support on covered calls:
Another income strategy is to go short stock and short a put options contract. This position is called a covered put because the short stock position can be used to meet the obligation created by the short put.
For example:
Sell short 100 shares of XYZ stock @ $32
Short 1 XYZ Jan 30 put @ $3
Income strategies are typically used in flat markets. If you sell short 100 XYZ shares at $32 and the stock doesn’t move much, you can sell a put to collect premium.
If XYZ falls below $30, the put goes in the money and may be exercised (the investor is “put to”). A short put obligates the writer to buy shares at the strike price.
A short put by itself can be very risky. If the stock falls to $0, a short 30 put still requires buying shares at $30, creating a $30 per share loss.
In a covered put, the investor has already sold the shares short at $32. If assigned on the put, the investor buys shares at $30 and uses them to close the short stock position. Because the short sale price is already locked in at $32, the investor is no longer exposed to the “buy at $30 and hold worthless shares” outcome that makes a naked short put so dangerous. This combination is called a covered put.
Let’s go through a few examples to understand this strategy better:
An investor sells short 100 shares of XYZ stock at $32 and goes short 1 XYZ Jan 30 put at $3. What is the gain or loss if ABC’s market price falls to $10?
Answer = $500 gain
| Action | Result |
|---|---|
| Sell short shares | +$3,200 |
| Sell put | +$300 |
| Assigned - buy back shares | -$3,000 |
| Total | +$500 |
This strategy is designed for a flat market, but here the stock fell sharply to $10. The put is in the money, so the investor is assigned and must buy shares at $30 to close the short stock position.
This creates opportunity cost. Without the short put, the investor would have gained $2,200 on the short stock (sold at $32, bought back at $10). By selling the put, the investor capped the profit and gave up any gains below $30.
The key idea is the same as with covered calls: in exchange for premium, the option limits how much the stock position can profit beyond the strike.
Income strategies are best for flat markets. Now consider a neutral market.
An investor sells short 100 shares of XYZ stock at $32 and goes short 1 XYZ Jan 30 put at $3. What is the gain or loss if ABC’s market price stays at $32?
Answer = $300 gain
| Action | Result |
|---|---|
| Sell short shares | +$3,200 |
| Sell put | +$300 |
| Buy back cost | -$3,200 |
| Total | +$300 |
The put stays out of the money and expires worthless. The short shares don’t gain or lose value, and the investor keeps the $300 premium.
Without selling the put, the investor would have no gain or loss. This is the income-strategy benefit in a flat market.
What happens if the market rises a little?
An investor sells short 100 shares of XYZ stock at $32 and goes short 1 XYZ Jan 30 put at $3. What is the gain or loss if ABC’s market price rises to $35?
Answer = $0 (breakeven)
| Action | Result |
|---|---|
| Sell short shares | +$3,200 |
| Sell put | +$300 |
| Buy back cost | -$3,500 |
| Total | $0 |
The put remains out of the money and expires worthless. The short shares lose $300 (from $32 to $35, times 100), and the $300 premium offsets that loss.
As with covered calls, the premium provides a cushion: the stock can move against the position by up to the premium received before the overall position becomes a net loss.
What happens if the market rises significantly?
An investor sells short 100 shares of XYZ stock at $32 and goes short 1 XYZ Jan 30 put at $3. What is the gain or loss if ABC’s market price rises to $100?
Answer = $6,500 loss
| Action | Result |
|---|---|
| Sell short shares | +$3,200 |
| Sell put | +$300 |
| Buy back cost | -$10,000 |
| Total | -$6,500 |
The put stays out of the money and expires worthless. The loss comes from the short stock position as the market price rises.
The option isn’t intended to be a hedge, but it does act as a partial hedge. Without the put premium, the investor would have lost $6,800 (sold at $32, bought back at $100). The $300 premium reduces the loss to $6,500.
Notice the important wording: “covered” refers to the put obligation, not the risk of the short shares. The short stock position still has unlimited loss potential unless there’s a true hedge (e.g., a long call).
Watch this video if you need additional support on covered puts:
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