How to Execute Covered Calls on Schwab

Covered calls can be a powerful strategy for generating income from your stock portfolio. By selling call options on shares you already own, you can earn premium income while potentially selling your stocks at a desired price. This article will guide you through the process of executing covered calls on Schwab, from selecting stocks to understanding the mechanics of options trading. Whether you're a seasoned investor or just starting out, mastering covered calls can add an exciting dimension to your investment strategy.

To start, you must own the underlying shares of the stock for which you plan to sell call options. This is crucial because a covered call strategy requires you to hold shares that back the options you sell. If you don’t own the shares, you would be engaging in a naked call strategy, which is riskier and not recommended for inexperienced traders.

Identify Suitable Stocks: Look for stocks that you believe have limited upside potential in the near term but still provide solid returns. Consider high-dividend stocks, as they tend to be less volatile. Use Schwab’s research tools to analyze stock performance, fundamentals, and market sentiment.

Understand Option Premiums: The premium you receive for selling a call option is critical. This premium compensates you for the obligation to sell your shares at the strike price if the option is exercised. Factors that influence option premiums include the stock’s volatility, the time until expiration, and the distance between the current stock price and the strike price.

Select the Right Strike Price and Expiration Date: Choosing the appropriate strike price involves balancing risk and reward. A higher strike price means less premium income but a higher chance of retaining your shares. Conversely, a lower strike price may yield more premium income but increases the likelihood of having to sell your shares. The expiration date can also affect your strategy; shorter durations usually yield higher premiums, while longer durations provide more time for stock price movements.

Executing the Trade on Schwab: Navigate to Schwab’s trading platform and locate the options trading section. Input the stock symbol, choose the call option you want to sell, specify the number of contracts (each contract represents 100 shares), and review the order. Ensure you have sufficient shares in your account to cover the calls. After double-checking the details, submit the order.

Monitoring Your Position: After executing a covered call, it's essential to monitor your position. Keep an eye on the stock price and the performance of the option. If the stock price approaches the strike price as expiration nears, you might consider rolling the option to a later date or a higher strike price to maintain income generation while retaining your shares.

Understanding Risks and Rewards: While covered calls can generate income, they also have risks. If the stock price rises significantly, your upside potential is capped at the strike price. Additionally, if the stock price drops significantly, your shares could lose value, offsetting the income generated from the option premium.

Tax Considerations: Income from options trading may have different tax implications compared to capital gains. Consult with a tax professional to understand how your covered call strategy may impact your overall tax situation.

Example of a Covered Call Trade: Let’s assume you own 100 shares of XYZ Corp, currently trading at $50. You decide to sell a call option with a strike price of $55, expiring in one month, for a premium of $2 per share. You receive $200 (100 shares x $2) for selling the call. If XYZ Corp remains below $55, you keep the premium and your shares. If it rises above $55, you will have to sell your shares at that price, but you still earn the premium.

Final Thoughts: Covered calls can be an effective way to generate income while managing risk. By understanding the mechanics of options trading on Schwab and selecting the right stocks, strike prices, and expiration dates, you can enhance your investment strategy. Start small, monitor your trades closely, and adjust your approach as necessary to maximize your success in covered calls.