Covered Calls & Cash-Secured Puts: Options Income Strategies

Introduction

Covered calls and cash-secured puts are two conservative options strategies that let you earn premium income using stocks you own or cash you have set aside. Both strategies are widely used by income-focused investors to enhance returns or to potentially buy stocks at a discount. Which one suits you depends on whether you already own the shares, your price target, and your willingness to hold or acquire shares.

Why does this matter to you as an investor? Options premiums can meaningfully boost portfolio income, especially in sideways or slowly rising markets. But options also introduce tradeoffs, like the chance your shares will be called away or that you'll be assigned stock at an undesired price. In this article you'll learn how each strategy works step by step, when to use them, how to size and manage trades, and real-world example trades using $AAPL and $MSFT.

You'll get practical rules for strike and expiry selection, risk management tips, and common mistakes to avoid. Ready to see how options can supplement your income strategy without taking speculative risks?

• Covered calls earn premium on stock you own, but you risk having shares called away if the stock rallies above the strike.
• Cash-secured puts earn premium and set a purchase price for buying stock, with assignment risk if the stock falls below the strike.
• Strike selection balances income versus likelihood of assignment. Shorter expiries raise annualized income but increase trade frequency.
• Use position sizing, margin awareness, and exit rules to limit downside and avoid concentrated exposure.
• Real examples: covered call on $AAPL and cash-secured put on $MSFT illustrate premiums, returns, and scenarios.

How Covered Calls Work

A covered call is selling a call option against shares you own. You collect a premium up front. If the stock stays below the strike through expiration you keep the premium and the shares. If it rises above the strike you may be assigned and must sell your shares at the strike price.

This strategy is commonly used when you expect neutral to modestly bullish price action. It provides immediate income, lowers your cost basis by the premium collected, and offers partial downside cushion equal to the premium. It does not eliminate downside risk if the stock falls significantly.

Mechanics, step by step

1. Own or buy 100 shares of a stock, for example $AAPL.
2. Choose a strike price above or near the current price depending on your view and willingness to sell.
3. Sell one call option contract per 100 shares and collect the premium up front.
4. Monitor until expiration, or close the short call early if you want to keep the shares or limit risk.

When to consider covered calls

• You want income while holding shares you already like.
• You expect limited upside in the near term but want to stay invested.
• You’re comfortable selling shares at the strike if assigned.

How Cash-Secured Puts Work

A cash-secured put involves selling a put option while holding enough cash to buy 100 shares per contract at the strike price. You collect premium up front. If the stock stays above the strike through expiration you keep the premium. If it falls below the strike you are assigned and must buy the shares at the strike price.

Investors use cash-secured puts when they want to generate income and possibly acquire a stock at a lower effective cost. The premium reduces your effective purchase price. The main risk is downside if the stock drops sharply below the strike after assignment.

Mechanics, step by step

1. Select a stock you would be willing to own, for example $MSFT.
2. Choose a strike price where you are comfortable being assigned and set aside cash equal to strike times 100 per contract.
3. Sell the put and collect premium. Keep the cash secured in your account until the option expires or you close the trade.
4. If assigned, buy the shares at the strike and reduce your net cost by the premium received.

When to consider cash-secured puts

• You want to buy a stock at a lower effective price while getting paid now.
• You have cash that can be put to work and you are comfortable owning the underlying if assigned.
• You prefer a defined downside exposure equal to owning the stock less the premium received.

Trade Construction, Strike & Expiry Selection, and Risk Management

Strike and expiry choices are the most important levers when constructing covered calls or cash-secured puts. They determine how much premium you receive, the chance of assignment, and your effective return or purchase price. You'll need to balance income goals with assignment risk and portfolio objectives.

Strike selection rules

• Out-of-the-money strikes give lower premiums but lower assignment probability. In-the-money strikes give higher premiums but increase the chance of being assigned.
• For covered calls, choosing a strike 3% to 10% above current price is common for moderate income while keeping upside potential.
• For cash-secured puts, choosing a strike 3% to 10% below current price is common if you want a margin of safety plus premium.

Expiry selection rules

• Shorter expiries, such as weekly or monthly, typically pay smaller absolute premiums but can generate higher annualized returns and allow you to adjust positions more often.
• Longer expiries provide larger upfront premiums but lock you into obligations for longer. Roll decisions become important with longer-term options.

Position sizing and margin

• Limit any single covered call or cash-secured put position to a small percentage of your portfolio, commonly 1% to 5% per trade depending on your risk tolerance.
• With cash-secured puts keep the full cash amount equal to strike times 100 in a safe, settled form. For covered calls avoid using margin for the underlying unless you understand the brokerage requirements.

Exit and management rules

• Have a plan before entering the trade: let it expire, close early, or roll the option to a later expiry or different strike.
• If the underlying moves quickly you can buy back the short option at a loss to avoid assignment, or roll up and out to a higher strike and later expiry if you want to remain covered.
• For covered calls be mindful of dividend dates if the short call is in-the-money, since early assignment risk rises when dividend capture is relevant.

Real-World Examples

Below are two realistic examples that show how covered calls and cash-secured puts perform across outcomes. Numbers are illustrative and not a recommendation. They show how premium affects returns and effective purchase price.

Example 1: Covered call on $AAPL

Assume $AAPL is trading at $170 per share and you own 100 shares. You sell one monthly 175 strike call for $2.00 premium per share. You collect $200 premium up front.

1. If $AAPL stays below $175 through expiry you keep your 100 shares and $200. That reduces your cost basis by $2.00 per share, equal to a 1.18% immediate yield on $170 for the month. Annualized this is about 14% if you repeated the trade, ignoring transaction costs and varying premiums.
2. If $AAPL rises above $175 and is called away, you sell your 100 shares at $175 and keep the $200 premium. Your gross proceeds are $17,500 plus $200, so your sale price is effectively $177 per share. That yields a realized gain of $7 per share from $170 plus the premium for a total of $700 unrealized plus $200 premium, a combined 5.88% return for the month.
3. If $AAPL drops to $155 you still keep the $200 premium, which reduces your unrealized loss. Your effective cost basis is $168 per share after premium, so the unrealized loss is smaller than if you had not sold the call.

Example 2: Cash-secured put on $MSFT

Assume $MSFT trades at $320 and you want to potentially buy it at a lower price. You sell one 300 strike put expiring in a month for $3.50 premium per share. You collect $350 and set aside $30,000 cash to secure the contract.

1. If $MSFT stays above $300 you keep the $350 premium and maintain your $30,000 cash. That is a 1.17% return for the month on the secured cash. Annualized it is a higher rate but depends on repeated opportunities.
2. If $MSFT falls to $290 and you are assigned, you buy 100 shares at $300 and your net purchase price is $296.50 after the $3.50 premium, a 7.03% discount from the original $320 market price.
3. If $MSFT collapses to $240 you still buy at $300 and your effective cost is $296.50, so you bear the full stock downside beyond the premium cushion. That's why position sizing and selecting strikes where you are comfortable owning the stock matters.

Common Mistakes to Avoid

• Overconcentration in one stock, which amplifies assignment and downside risk. How to avoid it, diversify and limit position sizes.
• Using strikes too close to the money without accepting the possibility of assignment. How to avoid it, pick strikes aligned with your willingness to sell or buy.
• Ignoring commissions, fees, and tax implications. How to avoid it, factor transaction costs into returns and consult tax guidance about short-term vs long-term treatment.
• Failing to secure cash for puts or using margin unwisely. How to avoid it, keep required cash available and understand your broker's margin rules.
• Letting options expire with dividend or earnings risk that could lead to early assignment. How to avoid it, monitor ex-dividend dates and earnings calendars and close or roll positions beforehand if needed.

FAQ

Q: What happens if I get assigned early on a covered call?

A: If you are assigned before expiration you must sell your 100 shares at the option strike. That means you lose ownership at that price and keep the premium. Early assignment can happen when the option is in-the-money and there is a dividend coming up or if the holder decides to exercise for other reasons. You can avoid or reduce early assignment probability by choosing out-of-the-money strikes and by closing positions before ex-dividend dates.

Q: Can I use cash-secured puts to buy shares during market dips?

A: Yes, cash-secured puts are a disciplined way to set a target buy price and collect premium while you wait. If the stock falls to your strike you'll be assigned and buy at the strike less premium received. If it never falls you keep the premium. Make sure you would be comfortable owning the stock at the strike in a down market.

Q: How do taxes work for premiums from selling options?

A: Premiums received are typically treated as short-term capital gains when the options expire or are closed, unless specific tax rules apply. If an option results in assignment resulting in a sale or purchase of stock, the premium adjusts the cost basis. Tax rules can be complex so consult a tax professional for your situation.

Q: Are covered calls and cash-secured puts safe strategies for conservative investors?

A: These strategies are considered conservative relative to naked options because obligations are backed by shares or cash. They still involve risk, primarily downside exposure to the underlying stock. If you want lower risk, combine options strategies with diversified holdings and strict position sizing. They are tools to manage income and entry price, not to eliminate market risk.

Bottom Line

Covered calls and cash-secured puts are practical, income-oriented options strategies for investors who want to generate premium while staying within defined, understandable risks. Covered calls work well when you own a stock and expect limited near-term upside. Cash-secured puts suit investors who want to buy a stock at a lower effective price while earning income while they wait.

Start with small, well-sized positions, choose strikes and expiries that match your willingness to be assigned, and use clear exit rules. Track premiums, fees, and tax impacts. At the end of the day options can be powerful tools for enhancing yields when used conservatively and with a plan.