How to Sell Covered Calls: Step-by-Step Guide for Income

A covered call is one of the simplest options strategies: you own 100 shares of a stock and sell a call option against those shares. The call gives the buyer the right to purchase your shares at a specific price (the strike) by a specific date (expiration). In exchange, you collect premium upfront. It is called "covered" because you already own the shares that back your obligation.

In the context of the wheel strategy, covered calls are the second phase. After being assigned shares via a cash-secured put, you sell covered calls to generate additional income and reduce your cost basis until the shares are eventually called away. But covered calls work just as well as a standalone income strategy on any shares you hold.

What You Need to Sell Covered Calls

The requirements are straightforward:

• 100 shares of the underlying stock. You must own at least 100 shares for each covered call contract you sell. If you own 300 shares, you can sell up to 3 contracts.
• Options approval Level 1. Covered calls are the lowest-risk options strategy, and virtually every broker grants Level 1 approval easily.
• Know your cost basis. This is your effective purchase price per share, including any premiums collected from prior CSPs. You need this number to select an appropriate strike.

For a conceptual overview of covered calls, see our covered call basics guide.

The Worked Example: MSFT at $420

Throughout this guide, we will use a concrete scenario. You own 100 shares of Microsoft (MSFT), purchased at $420 per share. Your cost basis is $420. MSFT is currently trading at $425. You want to generate income from these shares while you hold them.

Step 1: Select Your Strike Price

Strike selection is the most important decision in covered call selling. The key principle: always sell calls at or above your cost basis. Selling below cost basis means that if the shares are called away, you lock in a loss on the stock position.

Strike selection framework

For our example, we will select the $440 strike at a 0.25 delta. This gives us a 75% chance of keeping the shares (the call expires OTM) while collecting a respectable $420 in premium. The $440 strike is also well above our $420 cost basis, so if shares are called away, we profit $20 per share on the stock itself plus the premium.

Step 2: Choose Your Expiration

The same 30–45 DTE sweet spot applies to covered calls as it does to cash-secured puts. Theta decay is steepest in this range, giving you the best premium per day of capital commitment.

For MSFT, we select the April 4 expiration (30 DTE from our March 5 entry). The MSFT April 4 $440 call is trading at a bid of $4.10 and an ask of $4.30.

Step 3: Place the Order

1. Open the options chain for MSFT. Navigate to the April 4 expiration.
2. Find the $440 call in the call column. The bid is $4.10, the ask is $4.30.
3. Select "Sell to Open." You are creating a new short call position. Your 100 shares serve as collateral.
4. Set a limit order at the mid-price: ($4.10 + $4.30) / 2 = $4.20.
5. Confirm the order: Sell to Open, 1 MSFT April 4 $440 Call, Limit $4.20.
6. Submit. Once filled, you receive $420 in premium.

Use the covered call calculator to model these numbers for your own positions.

Step 4: Manage the Position

Close at 50% profit

If MSFT stays flat or drifts slightly lower, theta decay will erode the call's value. When the call is worth $2.10 (half of $4.20), buy it back. You lock in $210 profit and can immediately sell a new call at a later expiration, compounding your income more efficiently.

In practice: 12 days into the trade, MSFT is at $423. The $440 call has decayed to $2.00. You "Buy to Close" at $2.00, netting $220 profit. Now you sell a new May 2 $440 call for $4.50, starting a fresh 30-day cycle.

Let it expire worthless

If MSFT is well below $440 as expiration approaches (say, MSFT at $415 on April 3), the call is worth pennies. You can let it expire, keeping the full $420 premium. Your shares remain in your account, and you sell a new covered call the following Monday.

Roll if the stock rallies toward your strike

If MSFT rallies to $438 with a week to go, your $440 call is being tested. You have two choices:

• Accept assignment: Let the shares be called away at $440. You pocket $20/share capital gain plus $420 premium. Total profit: $2,420. This is the maximum profit scenario.
• Roll out and up: Buy back the April 4 $440 call and sell a May 2 $450 call. If this can be done for a net credit (even $0.50), you extend your time horizon, raise your potential exit price, and collect additional premium. Only roll if you still want to hold the shares.

Step 5: Handle Call Assignment

If MSFT closes above $440 at expiration, your shares are called away. Here is what happens:

1. Your broker sells your 100 shares at the $440 strike price.
2. You receive $44,000 in cash ($440 x 100).
3. Your total profit: ($440 − $420) x 100 = $2,000 capital gain, plus $420 premium = $2,420 total.
4. You are now back to holding cash with no stock position.

In the wheel strategy, this is where you restart the cycle. With $44,000+ in cash, you can sell a new cash-secured put on MSFT (or a different stock) to begin collecting premium again. The wheel has come full circle.

Track how your cost basis evolves across wheel cycles with our cost basis tracker.

Understanding the Upside Cap Tradeoff

The primary tradeoff of selling covered calls is the cap on upside. By selling the $440 call, you agree to sell your shares at $440 no matter how high MSFT goes. If MSFT rockets to $480, you still sell at $440. You miss out on $40 per share of additional gains.

Here is how to think about this:

The covered call outperforms in flat, slightly up, and down markets. It underperforms only in strong rallies above $440. This is the fundamental tradeoff: you trade unlimited upside for guaranteed income. For most income-focused traders, this is a tradeoff worth making consistently.

Covered Call Mistakes to Avoid

1. Selling calls below your cost basis. If your cost basis is $420 and you sell a $415 call, you will lose $5 per share if called away. Always sell at or above your breakeven.
2. Selling calls through earnings. If MSFT reports earnings during your contract period, the post-earnings move could blow through your strike. Either close before earnings or avoid selling calls that span an earnings date.
3. Selling too far out in time. A 90-day covered call ties up your position flexibility. If the stock drops early, you cannot easily sell the shares because they are encumbered by the call. Stick to 30–45 DTE.
4. Emotional rolling to avoid assignment. If you keep rolling up and out to avoid selling your shares, you are fighting the strategy. Assignment is a profitable outcome—embrace it when the time comes.

Summary: The Complete Covered Call Process

1. Own 100+ shares of a quality stock
2. Know your cost basis precisely
3. Select a strike above cost basis at 0.20–0.30 delta
4. Choose 30–45 DTE expiration
5. Sell to Open with a limit order at the mid-price
6. Manage: close at 50% profit or let expire worthless
7. If called away: collect profit, restart with a CSP
8. If not called away: sell another call, repeat

Each cycle grinds your cost basis lower and puts cash in your account. Over 12 months of consistent covered call selling, premium income of 8–15% on your share value is realistic for stocks with moderate implied volatility.