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What is the Average Return Selling Covered Calls?

Published in Options Trading Income 4 mins read

Selling covered calls typically aims for an average monthly return of 1-2%, which translates to an annualized return of 12-24%. This strategy is considered a sustainable and relatively low-risk approach within stock investment strategies, offering a consistent income stream.

Understanding Covered Call Returns

The target of 1-2% monthly, or 12-24% annually, is generally considered a reasonable objective when selling covered calls. While this might not be as high as potential returns from more aggressive trading strategies or direct stock appreciation, its appeal lies in its sustainability and lower risk profile. It provides a methodical way to generate income from your stock holdings, especially in neutral or moderately bullish market environments.

How Covered Calls Work

A covered call strategy involves owning 100 shares of a particular stock and simultaneously selling (writing) a call option against those shares. By selling the call, you collect a premium upfront. In return, you grant the buyer the right to purchase your shares at a predetermined strike price before a specific expiration date.

  • Income Generation: The primary benefit is the immediate income received from the option premium.
  • Reduced Cost Basis: This premium effectively lowers the net cost of your stock shares.
  • Risk Mitigation: It offers some protection against a small decline in the stock price, as the premium collected can absorb part of the loss.
  • Capped Upside: The main limitation is that your potential profit is capped at the strike price plus the premium received if the stock price rises significantly above the strike. Your shares may be "called away" or assigned at the strike price.

Factors Influencing Returns

Several variables can influence the actual returns you achieve from selling covered calls:

  • Implied Volatility (IV): Higher IV generally leads to higher option premiums, potentially increasing your returns. However, high IV can also indicate increased risk or uncertainty about the stock's future movements.
  • Stock Selection: Choosing stable, dividend-paying stocks or those with consistent demand for their options can provide more reliable income.
  • Strike Price and Expiration Date:
    • In-the-money (ITM) options: Provide higher premiums but increase the likelihood of assignment and cap your upside sooner.
    • Out-of-the-money (OTM) options: Offer lower premiums but allow for more stock appreciation before assignment, providing a balance between income and growth potential.
    • Time to Expiration: Shorter-term options (e.g., weekly or monthly) allow for more frequent premium collection, leveraging time decay more effectively.
  • Market Conditions: Bullish or sideways markets are generally favorable for covered call strategies, while rapidly declining markets can lead to losses on the underlying stock that outweigh the premium collected.
  • Management of Trades: Actively managing your positions, such as rolling options up or out, can help optimize returns and mitigate risks.

Typical Return Targets

The table below summarizes the typical targets for covered call returns:

Period Average Return Target Characteristics
Monthly 1-2% Consistent income generation
Annually 12-24% Sustainable, lower-risk strategy

Strategies to Optimize Returns

To consistently achieve these target returns, consider the following:

  • Strategic Stock Selection: Focus on fundamentally strong companies you wouldn't mind holding long-term, even if they are called away.
  • Volatility Assessment: Look for stocks with moderate implied volatility to earn decent premiums without excessive risk.
  • Strike Price and Expiration Alignment: Choose strike prices that offer a balance between premium income and potential stock appreciation. Often, selling slightly out-of-the-money options for 30-45 days out can be a good starting point.
  • Trade Management:
    • Roll Options: If the stock moves significantly, consider rolling your covered call to a different strike price or expiration date to capture more premium or avoid assignment.
    • Buy Back Options: If the option price drops significantly, consider buying it back to close the position and potentially write a new call.

By understanding these dynamics and actively managing your positions, covered call writing can be an effective way to enhance your portfolio's income generation.