Two scenarios for the covered call strategy Typically, the covered call strategy involves selling options that allow the buyer to purchase your stock at a price that's higher than the current market price. As a result, the strategy can generally work out in two different ways. If the stock stays below the agreed-upon payment price for the stock under the option -- also known as the strike price -- then the option buyer won't exercise the option. In that event, the option expires worthless, and the money that the buyer paid you for the option is yours to keep.

That's what many investors refer to as the dividend-like income boost from the covered call strategy. But the trade-off is that there's the danger that the stock will rise well above the strike price you agreed to in the option. In that case, the option buyer will exercise the option, and you'll be obligated to sell your stock at the agreed-upon strike price. That will be less than you could get in the market, and so you'll have missed out on the opportunity to sell your shares in the open market at a higher price.

Note that you still get to keep the money you received when you sold the option, which can at least partially offset the lost profits. In addition, if you set the strike price high above the current market price, it means that you'll have enjoyed a nice capital gain on your shares before selling them.

Many people use the covered call strategy as a way to generate income. Even though it's not typically a dividend, the proceeds from option sales that you receive gives you a stream of income that meets the same purpose for many investors. Want to learn more about stocks and how to invest? This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular.

Because the remaining time value of the options is less than the value of the dividends, owners of these calls will likely exercise their options 1 day prior to the ex-dividend date. To limit his exposure, Bob has several choices.

He can buy back his uncovered calls at a loss, buy the stock to capture the dividend, or sit tight and hope to not be assigned. If Bob had initiated an option spread buying and selling an equal number of options of the same class on the same underlying security but with different strike prices or expiration dates , he could also consider exercising his long option position to capture the dividend. If you are implementing a spread strategy that includes long contracts and short contracts, you need to remain particularly vigilant in regard to assignment risk. If both contracts are in the money and you are assigned on the short contracts, you will not be notified until the following business day.

While you can exercise your long position on the ex-dividend date to eliminate the short stock position that was created, you will still owe the dividend because you were short the stock prior to the ex-dividend date. If you are selling options covered or uncovered , there is always the risk of being assigned if your trade moves against you. This risk is higher if the underlying security involved pays a dividend.

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However, there are ways to reduce the likelihood of being assigned early. These include:. See Locating dividend information for ETFs for details. If you are a Fidelity customer and you have questions about your exposure to assignment risk, you can always contact a Fidelity representative for help.

Use this educational tool to help you learn about a variety of options strategies. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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A covered call writer forgoes participation in any increase in the stock price above the call exercise price, and continues to bear the downside risk of stock ownership if the stock price decreases more than the premium received. Skip to Main Content. Search fidelity. The content of this Web site is provided for general information purposes and should not be interpreted, considered or used as if it were financial, legal, fiscal, or other advice in any way.

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