Brian Lee
Jun 24, 2025
We previously covered a simple buy-sell cycle that’s likely to move slowly. It’s possible to make small trades at low frequency using only cash. However, once you start trading options, regulatory complexity increases. In this article, we’ll cover a few more core concepts required to understand covered calls.
Let’s talk about a few more concepts before we discuss covered calls.
The Intelligent Investor is a must-read. Warren Buffett credits it as the starting point of his investing career.
I’ve tried day trading before. Some days I made $30,000—but losses came just as fast. Without advanced tools, it’s extremely difficult.
That’s why I recommend a long-term approach. Focus on building assets that generate steady income. You can still trade when it makes sense, but the goal is sustainable profit—not quick wins.
Trading is a skill you can rely on even if you can’t work. Time-based income has limits. Asset-based income scales.
A broker is the financial institution that executes trades on your behalf in the stock and options markets. Brokers can be traditional firms like Fidelity or online platforms such as TD Ameritrade, Robinhood, or Schwab.
A margin account lets you borrow money from your broker to buy stocks or options. This is different from a cash account, where you can only trade with money you already have. Margin increases both your potential gains and losses, and comes with extra rules and risks.
Each broker has different requirements for opening a margin account, so check with yours.
With a margin account, you can qualify as a Pattern Day Trader (PDT) and trade more often. It also lets you trade without waiting for cash to settle after buying or selling.
Covered calls can be low effort, but once you understand options, you may want to trade more frequently. If you place four or more day trades in a five-day period, and those trades make up more than 6% of your total trades, you may be classified as a Pattern Day Trader (PDT).
This classification requires that you keep at least $25,000 in your margin account at all times. If you fall below that, your broker may restrict your trading activity.
Rules vary by broker, so review their guidelines carefully and ask questions. Brokers are usually happy to explain—your activity earns them fees and interest.
Even if you don’t meet the PDT requirements, I would not dismiss learning about covered call trading. Covered calls teach you how insurance arbitrage works.
Insurance arbitrage is the process of collecting income (the option premium) in exchange for taking on risk, similar to how insurance companies operate. You accept limited upside in return for consistent payments. Understanding this concept can save or make you significant amounts of money throughout your life as financial opportunities arise.
When you buy or sell a stock, the trade doesn’t settle right away. As of May 2024, the U.S. uses a T+1 settlement cycle—trades settle one business day after they’re made. If you trade on Monday, the cash and shares move on Tuesday.
This matters if you plan to reinvest quickly. With a cash account, you must wait for settlement before reusing the funds.
A margin account removes this delay. Since you’re borrowing from your broker, you can reuse sale proceeds right away. This gives you more flexibility, but also comes with added risk and rules.
Remember our discussion about debt-to-equity ratio? It’s important to keep margin usage low until you gain experience. Margin gives you flexibility, but also amplifies risk. Start cautiously and make sure you understand what’s involved in trading options with borrowed money.
A covered call is the most conservative option strategy. You must first buy 100 shares of the underlying to sell one covered call.
The term “underlying” refers to the stock or asset that the option contract is based on. In this case, the underlying is the stock you purchase and agree to sell if the option is exercised.
When you sell a covered call, you collect an option premium—similar to an insurance payment. The buyer of the call option then has the right, but not the obligation, to buy the underlying at the strike price agreed upon at the time of the sale.
Many stocks offer weekly options, which I have found to be very profitable. In the simplest case, you only need to make one trade per week.
For example, suppose you buy 100 shares of Ford at $10.50 each, costing you $1,050. You then sell a weekly covered call with a strike price of $11.00 for a premium of $0.10 per share. You immediately collect $10 in option premium. If Ford stays below $11.00 by expiration, the option expires worthless, and you keep both the shares and the premium. If Ford rises above $11.00, your shares may be called away (sold), and you still keep the premium plus the gain from $10.50 to $11.00.
Option assignment occurs when the option buyer chooses to exercise their right to buy (for a call) or sell (for a put) the underlying stock. If you’re the seller of the option, you are obligated to fulfill the terms—either selling or buying 100 shares at the strike price.
When you are buying into a position for the first time, avoid purchasing the underlying and the covered call separately. As discussed earlier, the stock market is random, chaotic, and continuously changing—a wild west of complex and dynamic variables. Therefore, it’s best to keep all decisions tightly grouped in time.
To enter a position effectively, use the buy-write method.
A buy-write is a type of order that allows you to buy 100 shares of the underlying stock and simultaneously sell one covered call option on those shares. This ensures that you secure both the shares and the option at the same time, reducing the risk of price fluctuations during execution.
When placing a buy-write order, I recommend using a limit order with a Day expiration. This gives you control over the price you pay and prevents the order from executing at an unfavorable price if the market opens with high volatility.
Avoid using GTC (Good-Til-Canceled) for buy-write orders. GTC orders may execute immediately at the market open, which is often the most volatile time of day due to the flood of pending orders. Since we’re not as fast as algorithms, this can result in a poor entry price.
For a conservative investor, it’s better to place the order manually during a calm period when the market conditions align with your investment plan.
Thus, my rule: never use market orders and never use GTC to buy into a position.
Of course, there are exceptions. If your GTC buy or buy-write order is set far below the current market price, you may want the order to execute at the open in the hopes that someone is panicking or has made a poor decision.
The strike price is the fixed price at which the buyer of a call option has the right to purchase the underlying stock.
When selling a weekly covered call, I find that the strike price matters more than the option delta. Covered calls are a conservative strategy, and in this role, you are essentially acting as an insurance company. Insurance companies make the most money when no claims are filed. What do they do with the surplus cash from collecting premiums? They invest it.
We want to do the same. The key is to recognize that collecting weekly premiums keeps your assets working for you with minimal effort.
What if your shares are called away (sold) at the end of the week? That’s not a problem. You can simply execute another buy-write order. Rinse-and-repeat every week.
It’s important to remember that building assets does not mean you must always hold onto the same assets. You can collect a reasonable profit, convert assets to cash, and use that capital to buy more assets or wait for the next opportunity. The goal is to continue building your access to cash and keep adding fuel to the fire.
For this reason, I would ignore delta—as long as you are confident that you will consistently collect premiums through covered calls or sell the underlying at a reasonable profit when called away.
For a conservative trader, I recommend executing buy-write orders to buy weekly covered calls on Mondays, since options expire on Fridays. This gives you a full week of premium exposure and keeps your trading rhythm predictable and manageable.
If you are more adventurous, you should study how options are priced in more detail. One of the key option Greeks is theta (\(\theta\)), which measures time decay. Theta tells you how much the value of an option decreases with each day that passes, assuming all other variables remain constant.
An option’s price consists of two parts: intrinsic value and time value. Intrinsic value is the amount by which an option is in the money. For a covered call, the option is in the money when the strike price is below the underlying stock price—meaning the option would generate a profit for the buyer if exercised immediately.
Time value is the additional premium traders are willing to pay for the possibility that the stock might move in their favor before expiration. The length of time until expiration has a direct effect on time value: the longer the time to expiry, the greater the time value. As expiration approaches, time value erodes, with the rate of decay accelerating during the final week.
Theta specifically reduces the time value portion of the option. This is why weekly options can be profitable for covered call sellers: they let you capture rapid time decay efficiently.
Do nothing. There are many ways to respond when the underlying stock price drops, but while learning, it’s best to keep things simple. Let the covered call expire and collect the premium. This teaches the rhythm of weekly option trades.
“Set and forget” is the best way to learn covered calls in the beginning. I rarely take this approach myself—I try to profit from market changes. We’ll cover that in the next article.
Let’s go back to Ford.
Today Ford opened at $10.75 and is trading at $10.80 while I’m writing this. As we’ve discussed before, this is a bad price—it’s just about \(0.3\sigma\). HV30 doesn’t change quickly since it tracks price movements over the past 30 days.
Looking at potential buy-write orders available to me, I see that I can execute a buy-write order expiring on June 27, 2025 with a strike price of $11 and a delta of 0.2342 or about 23% chance of option assignment. It will cost me $10.78 per share. Therefore, if the closing price of Ford is $11 or higher on Friday, I’ll collect the premium and make 2 cents per share, or $2 total.
If I lower the strike price to $10.50, I can collect a larger option premium because the delta increases to 0.8441 or about 84% chance of option assignment. However, I will pay $10.48 per share. This nets me the same profit. Either choice will work.
If you’d rather keep the shares by the end of the week, I recommend choosing the $11 strike price. If you’d prefer to get your cash back, choose the $10.50 strike price.
It gets more interesting once you start considering options that expire further into the future. Thanks to increased time premium, you can generate more profit. However, this can work against you if you are buying into the position with debt. Therefore, understanding how to manage debt is key.
As a reminder, stop thinking in absolute dollar amounts. Look at what percentage gain is possible. These may seem like small income; however, I’ll show you how to compound the returns by trading covered calls in the next article.
I also urge you to consider how fast you can compound returns. This is why I spent significant time understanding how to compound small profits daily to generate a meaningful monthly return. In a year or two, you may surprise yourself with how quickly you’ve generated value.
Don’t earn money by exchanging your time for a dollar. Learn to generate money by improving your skills, increasing your knowledge, and reducing the time and effort required to produce income.