Covered calls can be an excellent income source for stock investors, but it can be confusing to select the best option expiration for the call being sold.
The further out the option expiration, the higher the premium and the longer the stock has to reach the strike price. How far out you should sell covered calls, then, is a factor of how much premium you want to collect, the amount of time you want to spend, and the underlying security’s speed of movement.
In this post, I’ll expand on these factors to help you decide how far out you should sell covered calls based on your own goals and the attributes of the underlying stocks or ETF’s.
I’ve sold hundreds if not thousands of covered calls stocks and ETF’s over the years. I write based on what I learned first hand about how far out you should sell covered calls.
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Are Near or Far Out Covered Calls Better?
To discern if selling near or far out covered calls is better for you, begin by reviewing your goals for selling covered calls.
If your goal is to get the highest option income possible, you’ll probably want to sell covered calls that are not far out to increase the number of times you can collect option premiums.
On the other hand, if you’re more interested in passive income with less effort, you may prefer covered calls that are far out since you will sell far out covered calls less frequently.
What Is Considered a Far Out Covered Call?
Covered calls with an option expiration date within days or a few weeks are considered short term.
On the other hand, covered calls with an option expiration date more than five to six weeks away is considered far out by most covered call writers.
Advantages and Disadvantages Selling Covered Calls Near in Time
Everything comes with the good and the bad. Let’s cover the pros and cons of selling short term covered calls first. Then we’ll do the same for covered calls with an option expiration that is far out.
Advantages of Short Term Covered Calls
Predictability
Short term options have less risk than far out call options because there’s less time for the unknown to happen to the underlying security the closer the option expiration date is.
Similarly, short term covered calls have less risk simply because the short term is more predictable than the long term.
In the short term, pricing of the underlying stocks used for covered call writing is less likely to be affected by unknowns, such as earnings announcements, dividend rate changes and random unknowns, like Black Swans and bear markets.
This increased predictability favors covered calls that are near term vs long term in terms of risk, but not in terms of income as you’ll see ahead.
Ability to Sell More Covered Calls
Short term covered calls allow the call writer to sell more covered calls than a call writer with covered calls that are far out in time.
Every time a call option is sold, premium gets deposited to your account, thereby increasing income. This is one time that less is not necessarily more and near term covered calls have the advantage here.
Weekly Options
Weekly options are very short term options that expire weekly instead of monthy. They’ve become hugely popular. Covered calls on weekly options can easily be sold four times a month instead of once a month, like monthly call options. They can even be sold several times a week but then you’re getting into a lot of effort to do that.
Higher Trading Volume
Close in options are much more likely to have generous trading volume on active stocks and ETFs making them easier to sell and at better prices. Better price fills equate to higher profit potential from covered call writing.
Additionally, it’s just easier to trade high volume options. The option trades get filled quicker.
Pros and Cons of Selling Covered Calls That Are Not Far Out / Less Than 6 Weeks Out
| Near Term Covered Call Advantages | Near Term Covered Call Disadvantages |
| Predictability | More Effort |
| Increased Covered Call Volume | Higher Trading Expenses |
| Higher Trading Volume | Higher Taxes |
| Weekly Options | Loss of Time Value |
| Improved Use of Investment Capital |
Disadvantages of Short Term Covered Calls
More Effort
Despite the ability to receive option premiums more often, short term covered calls are definitely more work. There is something nice about the lack of effort from selling call options two to three months out occassionally.
In addition to the time it takes to sell the call options, accounting and related taxes must be considered for every time a call option is sold, adding even more effort to short term covered calls.
Higher Trading Expenses
More frequent call writing also means higher trading costs. Fortunately, this is less of an issue since trading commission competition has become fierce over the past two decades.
Loss of Time Value
One of the biggest advantages of covered call writing is the option seller’s ability to take advantage of time decay, as explained more below.
With short term options, however, the call writer loses most or all of this advantage since the option has little if any time decay built into the option pricing when the call is sold.
Higher Taxes
Taxes usually need to be paid on the option premium income that gets deposited into your account every time a call option is sold. This means the more transactions, the more accounting to report on your tax return. If course, this is now easily done with your brokerage statement.
Moreover, since covered call writing typically produces short term capital gains, the tax rate on covered call income is usually taxed at a higher rate, adding insult to injury.
Note that covered calls can be sold inside most retirement accounts to help alleviate this problem.
Of course, lower taxes are a secondary goal to making more income.
Advantages & Disadvantages of Selling Covered Calls Far Out
Next, let’s look at both the pros and cons of selling far out covered calls. Remember, in this post, anything that involves selling call options farther out than 6 weeks is considered far out or long term in nature as far as covered calls go.
Advantages of Far Out Covered Calls
Higher Call Option Premiums
The longer the time frame, the more income you get when selling a call option due to the time factor built into the option pricing.
Option sellers benefit naturally from the gradual decline in option pricing. This is a huge benefit of selling covered calls, period. Sellers of far out covered calls benefit from this pricing dynamic more than investors that sell near term covered calls.
More Passive Income
Call options will only be sold more than 6 weeks out resulting in less effort than selling covered calls short term covered calls more often.
There’s also less accounting with fewer transactions. Selling covered calls that are far out, then, make the income received even more passive income.
Lower Expenses
Selling far out covered calls results in fewer covered call positions being sold, which lowers trading expenses.
Ability to Increase Call Premiums
Far out covered call strategies result in a longer time frame when earnings announcements, dividend accouncements, or both occur before the options expire.
The higher uncertainty associated with earnings and dividend announcements increase the price of the call options sold. This dynamic increases option premiums, which is a benefit for the seller.
Dividend Income
In addition to higher premiums from potential dividend annoucements, covered calls that are sold far out often get to capture the dividend paid by the underlying stock since these stocks are held for longer time frames. Dividends are usually paid quarterly, so a covered call written with an expiration that is three months out has good potential to capture dividend income.
Disadvantages of Long Term Covered Calls
Higher Bid Ask Spreads
As written above, long term options often have lower volume than short term options, and this equates to a higher spread between the bids being made by buyers and sellers. This makes it harder to sell an option at the price you need to achieve your desired profits due to the higher bid ask spread.
It also takes longer to sell call options when there is a large bid ask spread since you’re unlikely to put in a market order due to a likely undesirable order fill.
Fewer Income Opportunities
A short term covered call writer may receive premium income roughly ten to forty eight times a year! A long term call writer, on the other hand, may receive option premium income roughly four to eight times a year, depending on the option time frame chosen.
Higher Risk
Many long term covered call writers sell options three months out. Since both earnings and dividends are announced quarterly, both of these factors increase the risk associated with owning the underlying security for long term covered call strategies due to the lower stock price predictability.
If a company cuts the common stock dividend, for example, the stock’s price can tank. And earnings misses often lead to big drops in stock prices.
One thing is for sure; you never know what will happen when it comes to stock price movement; sometimes the crazy stock market will interpret seemingly negative data in a positive way. In general, however, the underlying stock has a much higher probability of falling when negative news is announced.
Earlier earnings and dividend announcements were written as a pro to selling covered calls far out, and this is true. The other side of that uncertainty, however, is increased risk. There’s always a trade off.
Optimizing Capital for Covered Calls
A stock in a strong and fast uptrend is more likely to reach the option strike price in less time than a slow moving stock.
Such a stock is more likely, therefore, to exceed the option strike price weeks or even months before the option expiration date when selling far out covered calls.
When this happens, your capital is tied up until the option expiration date in a stock that has already reached it’s maximum potential, except for possibly capturing dividends.
This means that the further out the covered call is, the less efficient the position is from an investment capital perspective.
One of the most common complaints about selling covered calls is missing out on the capital gain if the underlying stock rises since option sellers are committed to sell the stock at the option strike price.
This disadvantage is less likely to occur when covered calls are sold close in vs far out in time. It applies to fast, up trending stocks, in particular.
Covered Call Tip: I like to look at a stock chart to see how fast or slow the underlying stock or ETF typically moves when selecting how far out to sell covered calls.
Pros and Cons of Selling Covered Calls Far Out / More Than 6 Weeks Out
| Far Out Covered Call Advantages | Far Out Covered Call Disadvantages |
| Passive Income | Higher Spreads |
| Higher Call Option Premiums | Less Covered Call Writing |
| Lower Trading Fees & Taxes | Higher Risk |
| Higher Premiums From Earnings & Dividend News | Inefficient Use of Covered Call Capital |
| Dividend Capture |
How Far Out I Like to Sell Covered Calls
My preference is selling overed calls that are 4 to 6 weeks out. Why?
I’ve learned that selling covered calls that are 4 to 6 weeks out:
- The option is far out enough to still have some time decay potential
- Allows me to think in terms of monthly income
- Optimizes investment capital
- Generates somewhat passive income; it doesn’t take much effort for meaningful income
The Most Important Thing About Covered Calls
As an older investor, I’ve learned the importance of prioritizing risk management as I teach in my investing course. As a writer and financial coach, I feel I must mention that covered calls work best in a bull or sideways market since investors must own the underlying stocks or ETF’s. The truth is it’s hard to sell basic covered calls in the occassional bear market since the underlying stocks are more likely to decline in price under the option strike price. This is true for both close in and far out covered calls.
Let me address covered call risk a little more for those who try to avoid losing money in the stock market as I do.
Most investors already have stock market risk anyway. In this case, selling call options increases investment income from those stocks without increasing risk. Covered calls actually decrease risk from owning stocks since the option premium collected offsets the cost of the underlying stock or ETF.
Investors considering covered calls, then, will always want to consider if the amount of stock market risk they have is appropriate for them; that’s where the risk lies with covered calls. This is why I advocate that selling far out covered calls can make sense for someone that owns stocks anyway as explained in the two examples below.
- Some of my older financial coaching clients have large positions in one stock they have owned for a long time They frequently insist on keeping the stock, often due to an emotional attachment related to employment before retirement. Selling out of the money call options, particularly far out in time, can be a good way to generate retirement income from those long time stock positions.
- Buy and hold investors of stock or ETF portfolios can also sell out of the money call options that are a few months out since buy and hold investing usually results in long term capital gains in the stocks or ETF’s owned. Likewise, investors who create a diversified portolio that includes defensive investments such as bonds and gold may also have the potential to sell call options on those assets since they tend to go up when stocks go down.
The Best Time Frame for Covered Calls
As you have seen, there are many advantages and disadvantages to both close in and far out covered calls. The charts above quickly reveal that the pros and cons for near term vs far out covered calls are about equal.
Take a look at your own investing goals to determine how much income you want to make. Then consider your lifestyle regarding how much time you want to dedicate to selling and managing covered calls. This will guide you to whether selling covered calls that are near or far out will be best for you.
The best place to start is with my Ultimate Wealth Plan. You can get it here now.
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