In the Money Covered Call Strategy


Selling in the money covered calls can be an excellent income generating strategy for those living off investments. 

An in the money covered call strategy involves selling a call option with a strike price higher than the cost of the underlying stock to increase income from stocks.  

After writing covered calls over the past 13 years, I have found that there are times when an in the money covered call strategy works better than an at the money or out of the money covered call strategies.   

After investing for almost 40 years, I’ve learned to address the risk involved with any investment first and foremost since you have less time to rebound from losses the older you get, so let’s do that first.  

Risk from Selling in the Money Covered Calls

In the money covered calls tend to be the least risky covered call strategy since they tend to lower your stock cost the most because the option income is the highest, as explained ahead. 

The reality is that covered calls are subject to overall stock market risk, with slightly less risk than owning stocks or stock funds without a covered call strategy.  

For this reason, you’ll want to always make sure investing in stocks is within your acceptable risk level before even considering selling covered calls, even though the income generated from them is tempting, usually ranging at least two to twenty times that of typical dividend income. 

When to Use an In the Money Covered Call Strategy 

Below are several factors to consider before using an in the money covered call strategy.    

Higher Income from Covered Calls 

The closer the strike price is to the market price of the underlying security, the higher the premium is with a covered call strategy. This means that in the money covered call strategies generate higher income than out of the money covered call strategies.  

If you’re looking to increase income from covered call writing, it’s worth considering using in the money covered calls. But there is trade off for this income, and more to consider so keep reading.   

More Covered Calls Get Exercised 

You’ll want to decide if you prefer that your covered calls get exercised or not. While this isn’t completely under your control, the covered call strategy used will affect the probability that positions will get called at option expiration.   

Managing Covered Calls 

If you hate managing covered calls, in the money strategies may be best for you since more in the money covered call positions get exercised than at the money or out of the money covered call strategies 

This is simply because the strike price is lower with an in the money covered call strategy than it is with an at the money or out of the money covered call strategy.  

New Covered Calls Monthly 

On the other hand, if you easily find ideas for covered calls and enjoy researching new stocks, you may want all your covered calls to get exercised so you can enter new positions each month to 6 weeks. (I like 4 to 6 week covered call strategies but there are many other time frames, including weekly options.)  

Another advantage is that having all your covered calls exercised each month provides capital for fresh positions without having to allocate more capital to stocks designated for covered callsRead my related post on the cash allocation in a portfolio 

My experience has been that usually the very first covered call on a new position has the best return over managed positions. Likewise, new covered call trades each month tend to generate more income.  

We all know there’s no such thing as a free lunch so you may be wondering if it’s more work managing in the money covered calls that didn’t get exercised or starting new covered calls each month.  

In my humble opinion, managing covered calls is probably a little less work, but that’s offset by the reality that it doesn’t generate as much income as new monthly trades. At Retire Certain, it’s important to decide how much time you want to spend on your income streams first, and then implement income generating and wealth building strategies from that decision so you can live how you want  

Read my related post How to Create a Wealth Plan that explains this more.  

Note that if you have good covered call screener and stock research tools, the time it takes to find covered call ideas is greatly reduced.  

The other factors for when to use an in the money covered call strategy are shorter but super important so keep reading.  

Underlying Stock Is Headed Down 

If you think a stock is headed down, selling an in the money option can be the best strategy.  

For example, you may have checked a stock chart and seen that the stock is at the high end of the recent trading rangeIf you’re new to stock charts, while technical analysis can seem daunting, very basic technical analysis can be an incredibly valuable tool for choosing the best covered call strategy to use at any given time.  

Alternatively, you may have an insight about an upcoming event, such as company earnings or competition, that will likely cause the stock to drop.  

In this case, an in the money covered call strategy may work the best as you’ll see below in the example.   

The Stock Market Is Declining 

The worse thing for covered call writing is experiencing bear markets. That is, until they are over, and then they are excellent opportunities for selling covered calls, especially out of the money covered calls.   

If the overall market is trending down, however, it usually makes more sense to sell in the money call covered calls than out of the money covered calls and here’s why. 

Read my related post Are Covered Calls a Good Idea?  

Out of the Money Covered Calls in Bear Markets 

First, the further away the strike price gets from the current stock price, the less income generated since the option premium (price) is lower. This is the case with out of the money covered calls.  

Second, if you’re selling out of the money calls in down trending markets, those out of the money covered calls are unlikely to get exercised.  

When this happens, all your covered call capital gets tied up those covered call stocks that didn’t get exercised 

And since the market is declining, it is harder to sell call options near your stock purchase price. This leaves all your capital tied up with little if any income from stocks.    

For retirees and others living off investments who count on covered calls for income, this can be a real challenge. That’s why we have created diversified multiple income streams over the past 15 years in real estate, stocks, and online business.   

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In the Money Covered Calls in Bear Markets 

Again, selling basic covered calls is hard during bear markets. This is true for out of the money and in the money covered calls. This is why I like to rely mostly on other income streams during overvalued stock markets and bear markets.  

Fortunately, however, even when the overall market is declining, stocks move up and down in smaller cycles within the over cycle down. This allows an in the money covered call strategy to capitalize on those mini cycles.  

Since an in the money covered call strategy is generally used for stocks likely to decline, and they tend to get called, they can be advantageous during bear markets.   

Read my related post Problems with Covered Calls 

Income Over Capital Gains 

Based on your overall wealth plan, you may find that you want income more than capital gains. An in the money covered call strategy usually generates higher income while reducing or eliminating capital gains.  

This is simply because when the covered call is exercised, the option seller has to sell the stock at a lower (strike) price with an in the money covered call than an out of the money covered call.  

In the Money Covered Call Example    

Here is an example of an in the money covered call strategy.   

Alex bought 600 shares of Retire Corp for $18.50 a share on May 16She wanted to generate some income from the stock, so she sold 6 June call options with an $18 strike price for $1.40 each 

This gives the call purchaser the right to buy the stock from Alex at $18 on the third Friday of June (option expiration), or June 15 in that particular year 

It’s important to note that Alex immediately got $800 deposited into her brokerage account for the sale of the options that she keeps regardless of what the stock price does.  To see why covered calls can be an excellent income generating strategy for those living off investments, compare this to typical stock dividend income.  

Covered Call Income Generated from Retire Corp.  

The $800 comes from the following calculation: 

$1.40 per option contract x 6 contracts x 100 = $840  

When I sell in the money covered calls, I know that I may have to sell the stock at a loss. If so, this loss will offset the income generated from selling the call option as explained more ahead.   

How Many Stocks Does One Option Contract Represent? 

In this example, I multiplied the option equation above by 100 because 1 option contract equals 100 shares of stock.  

So, by owning 600 shares of Retire Corp, Alex was able to sell the 6 option contracts.  

Covered Call Taxes and Commissions 

Taxes and brokerage commissions are excluded from the calculations in this post. They should be considered based on your own situation.   

The good thing for covered call investors is that stock and option commissions have gotten very cheap over the past two decades due to competition, especially with the ability to buy and sell securities online.  

Additionally, many investors sell covered calls in IRA’s to eliminate or reduce taxes.   

Unless Alex buys back the call option, what happens on options expiration depends on the price of the stock on June 15the third Friday in June that year 

What Happens at Options Expiration for in the Money Covered Calls?  

One of 3 things could happen at option expiration as outlined below.  

1. Stock Closes at the Strike Price on Options Expiration 

In this scenario, Retire Corp closed at exactly $18, or at the money. This is not common but stick with me because it’s important to understand.   

The option buyer may or may not “exercise” the option (buy the shares of Retire Corp) since the option strike price is the same as the market price on option expiration. Either way, Alex kept the $800 from the option sale. 

Assume the option buyer did not exercise the option by buying the stock. At this point Alex has several options. (Pardon the irresistible pun.) 

Sell Another Call Option 

Alex can sell another call option for the next month. Note that since the stock price has dropped from her purchase price of $18.50, the income generated will not be as good as the prior month since the stock price (and related option) is lower. 

Remember, the prior month, the stock was at $18.50. This was the market price when she sold an in the money call option for $1.40 with an $18 strike. This is one reason so much income was generated from  this particular covered call; it was deep in the money 

The high income trade off with in the money covered calls is that the stock can be called at a loss 

This is why doing the option expiration math for all 3 potential outcomes is important before making covered call investments.  

Read my related post Does Living Off Covered Calls Really Work? 

Sell a Call Option After Stock Rises 

Alternatively, Alex can watch the stock chart and sell a call option near the top of the current trading range to get a higher option premium.  

Sell a Call Option with More Time Value 

Alex can sell a call option for two or more months out, increasing the option premium by increasing the time value. Decay of time value is a huge advantage for option sellers that naturally happens with  covered call writing.  

Sell the Stock 

Alex can simply sell the stock and close the position.  

In this case, Alex would have made $800 from selling the call options. This would be offset by a loss on the stock of $.50 per share assuming she sold it at $18.    

2. Covered Call Expires In the Money  

In this next possible outcome, assume Retire Corp closes below $18, or in the moneyIclosed at $17.16 

The option buyer didn’t exercise the option since the market price of the stock on expiration day is below the strike price. The option buyer could simply buy the stock for less than the strike price of $18. 

It was a little bit of a bummer for Alex, because the stock had dropped in value since it was bought at $18.50. But the good thing is that Alex gets to keep the $ 1.40 for selling the option anyway, which reduces her Retire Corp position cost per share cost to $17.10 

She would be close to break even on the overall position if she sold her stock at option expiration.  

3. Stock Closes Out of the Money on Option Expiration  

Assume Retire Corp closed at $19.00, or out of the money. The option buyer would have logically exercised his right to BUY the shares at the strike price of $18 since the stock price was $1 more than the strike price at option expiration 

In this case, Alex would have to sell Retire Corp. below the market price of $19.50 but she is okay with that since she did the math for all 3 possible option expiration outcomes before choosing the best covered call strategy given the evaluation 

Alex would have made $560 on the overall position as follows: 

Loss from Retire Corp Stock

Sales Price of Stock          $18.00 

Cost of Retire Corp          $18.50 

Loss on Retire Corp           $(.50)

Income from Covered Call Investment 

Income from Sale of Option   $1.40

Less Loss on Retire Corp       –    .50

Net Profit per Share                   $.90 

Number of Shares                       600 

Total Profit                           $560 

As you can see, all the profit from this covered call investment came from the sale of the option premium, as is often the case with in the money covered call strategies.

Keep in mind this is income on one month’s profit from just one covered call position. You can see why covered calls can be a great income generator for stock investors who are already exposed to stock market risk anyway.  

Annualized Covered Call Return

Alex’s annualized return on this in the money covered call strategy would be:

Option Net Profit/Cost of Retire Corp$ .90/18.50 = .049 x 12=59% annualized 

This isn’t to say that this same return on investment could be made if this investment were made repeatedly throughout the year. In order to compare a monthly or six week return to an annual return, such as dividend income of 3% a year, it helps to calculate covered call returns annualized.

This turned out to be a very profitable covered call trade for Alex with a stock that decreased in value. I usually enter in the money covered call strategies, however, with the expectation that the stock will decrease in value.  

Lowering Stock Risk with In the Money Covered Calls 

Stop losses can be set to significantly lower stock risk when selling covered calls. This works especially well with in the money covered calls since the overall position cost is lower due to the high option premium.   

A lower overall stock cost lowers risk. This lower stock price can also serve as a good place for a stop loss to lower investment risk from stocks. I like to check this on a stock chart while also factoring in the risk I am willing to accept.  

At times of high volatility, for example, I have gotten to a 1% loss potential while selling covered calls. Let me know in the comments if you’d like to know more about covered call risk management and I can write a post about it.    

Click here to see how a stock market crash will affect you 

Summary for In the Money Covered Call Strategy 

As you may have guessed, not all in the money covered call investments are profitable, but many are. Before deciding whether to use an out of the money, at the money or an in the money covered call strategy, consider the above factors, such as overall stock market direction and your own goals. 

This top down analysis will guide you to the best covered strategy to reach your goals.   


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Disclaimer: Nothing in this post is meant to be taken as personal financial advice. You are responsible for your money

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