In the Money Covered Call Strategy | Benefits and Examples


Selling in the money covered calls can be an excellent income generating strategy for stock investors trying to live off investment income. 

An in the money covered call strategy involves selling a call option with a strike price lower than the market value of the underlying stock. This strategy is commonly used when the call writer expects the stock price to decrease, or to increase the probability of the option being exercised.    

After writing covered calls for over 17 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 strategy.   

In this post, I’ll address the following: 

  • Super important risk management related to covered calls 
  • When it’s best to use an in the money covered call strategy, depending on your goals
  • 7 important factors to consider before using an in the money covered call strategy 
  • Exactly how an in the money covered call strategy works
  • Specific in the money covered call strategy details 
  • The three potential outcomes for an in the money covered call strategy based on the underlying stock price at option expiration

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In the Money Covered Call Risks

Most investors just assume selling covered calls is risky since it involves options. Let’s address risk from in the money covered calls specifically. 

Stock Market Risk When Selling Covered Calls 

The reality is that all covered call strategies are subject to overall stock market risk, as well as stock specific risk, just like owning stocks are subject to these same risks.  I often write that selling covered calls can be an ideal income stream for investors who already have stock market risk in their portfolio anywayIn fact, many stock investors live off covered calls since they increase income but not risk.

Selling covered calls slightly reduces stock risk over owning stocks outright without a covered call strategy sold against them. This is because the call option income offsets the cost of the stock the minute the call option income hits your brokerage account. And this happens immediately after the call option is sold against the stock.   

In this regard, in the money covered calls, tend to be the least risky of the three covered call strategies, and here’s why:

In the money strategies offset stock cost more than other covered call strategies because the covered call writer gets the highest premium when selling in the money options, as explained ahead.

And these higher premiums lower the biggest risk of using covered call strategies: risk of the underlying stock dropping due to either the overall market or stock specific bad news. 

Warning: It’s easy for investors to get lured into writing covered calls before carefully evaluating stock market risk because the income is so high relative to dividends; the income generated from selling covered calls usually ranges at least two to twenty times that of typical dividend income!

Therefore, when it comes to risk and covered calls, investors will want to confirm that investing in stocks is within their own acceptable risk level before even considering covered call strategies.

In my post Does Living Off Covered Calls Really Work? I go into a lot of detail about stock market risk as related to covered call writing so I suggest this post for anyone that is unclear about stock market risk as it relates to covered calls specifically. 

Risk from ITM Covered Calls

It was previously addressed that in the money covered call risk was lower than the other covered call strategies due to the high option premium offsetting the cost of the stock.

On the other hand, an offsetting risk component specific to in the money covered calls is that the stock is more likely to get sold at a loss than other covered call strategies due to the strike price being less than the cost of the stock.  If this is confusing, keep reading, as it will all make sense by the time you finish this article. 

Now that risk related covered calls in general, as well as risk specifically related to in the money covered calls, let’s see how an in the money covered call strategy works, as opposed to other covered call strategies.

How Does an In the Money Covered Call Strategy Work?

Let’s say that Ali buys 100 shares of stock in Income Streams, Inc, for $100. This will be the underlying stock against which she sells in the money call options for some extra income.

Income Streams, Inc. is considered a high quality, relatively safe stock. Based on the stock’s chart, however, Ali thinks the stock has a good probability of declining in price over the short term because it’s at the top of its recent trading range.

With this in mind, she decides to sell a call option with a $99 strike for $2 instead of a call option with a $100 strike for $1.50 against her Income Streams, Inc. shares.

Here’s how Ali looks at it.

If the stock drops to $97 by the option expiration date, the option won’t be exercised. She will keep the stock, with the plan to sell another call option soon at an opportune time. She anticipates the stock will move back toward the high end of its trading range within a week or two based on the stock’s recent trends.

Ali made a nice $2 per contract for the in the money call option she sold.

Ali’s example gives you a basic and broad idea of why a covered call seller may choose an in the money covered call strategy vs an out of the money covered call strategy. Let’s go into more detail about in the money covered call strategies based on investor goals.  

How to reitre when you want

When to Use an In the Money Covered Call Strategy 

As you saw in the example above, an in the money covered call strategy is commonly used when:

  1. The covered call writer is more driven by option income vs capital gains such as during retirement
  2. The call seller wants the option to be exercised
  3. The underlying stock price is expected to decrease near term

Let’s look at each of these times you may want to use an in the money covered call strategy in more detail. 

1. Income from Covered Calls Vs Capital Gains 

In the money covered calls sacrifice capital gains when the option gets exercised. 

Therefore, in the money covered calls are best for investors who need income more than capital gains, like in retirement.

An in the money covered call strategy usually generates higher income while reducing or eliminating capital gains. This is because when an in the money 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.  

2. In the Money Covered Calls Get Exercised

The likelihood of an option being exercised is much greater with in the money covered calls. This can be a good scenario as addressed in more detail ahead. 

3. Underlying Stock Is Headed Down 

If you think a stock is headed down, as was the case in the example above with Ali’s stock, selling an in the money call option can be the best strategy.  

Like Ali, you may have checked a stock chart and seen that the stock is at the high end of the recent trading range. Note that if you’re new to stock charts, while technical analysis can seem daunting, very basic technical analysis can be an incredibly valuable tool for evaluating whether it’s best to use an in the money covered call strategy vs another strategy.  

Alternatively, you may have an insight into an upcoming event, such as company earnings or a new competitive product, that will likely cause the stock to drop, ideally, only on a temporary basis.  In this case, an in the money covered call strategy may work the best as you’ll see in the math presented in the example later.   

7 Important Factors for In the Money Covered Call Strategies

You’ve seen when you might want to use an in the money covered call. Below are 7 important factors to consider, however, before using an in the money covered call strategy   

1. Higher Income from In the Money Covered Calls 

The deeper in the money the strike price is to the market price of the underlying security, the higher the premium from a covered call strategy is. Again, this means that in the money covered call strategies generate higher income than out of the money covered call strategies.  

If increasing stock income by selling covered calls is the primary objective, it’s worth considering in the money covered call strategies. Who doesn’t want higher income for the same amount of capital at risk?

There is tradeoff for this income, however, and more to consider as explained below.  

2. In the Money Covered Calls Get Exercised 

You’ll want to decide if you prefer that your covered calls get exercised or not. While it’s not completely under your control whether a call option gets exercised, the covered call strategy used will definitely affect the probability that positions will get called at option expiration.   

The deeper in the money the call option is, the greater the probability it will get exercised.

All is not lost if it looks like an option will get exercised when you don’t want it to be; rolling covered calls that you don’t want to be exercised is a common strategy that can work well. 

3. Manage Fewer In the Money Covered Calls 

One negative with selling covered calls is having to manage positions that don’t get exercised.  

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 thereby increasing the probability the call option will be exercised. 

4. New Covered Call Positions

If you enjoy researching stocks and easily finding new ideas for covered calls, you may want all your covered call positions to get exercised so you can enter new positions more often.

Finding new stocks for covered calls can be time consuming, however.

If you struggle to find new stocks for covered call positions, out of the money call options may be more convenient since they’re less likely to be exercised than in the money covered calls. Out of the money covered call positions are more likely to allow you to sell call options repeatedly against the same stock position, thereby reducing the need to find additional suitable stocks.

5. Investment Capital for In the Money Covered Calls

Another factor to consider for in the money covered call strategies specifically 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 calls. After a covered call is exercised, and therefore the stock sold, the cash used to own the stock is available for new covered call positions. 

One of the absolute worst things about covered call strategies is getting stuck with all your investment capital tied up in growth oriented non-dividend stocks which cannot generate income from covered calls. In the money covered call strategies lessen the likelihood of this happening. 

6. Covered Call Selling Frequency

Remember that a core principle at Retire Certain is to decide how much time you want to spend on your income streams first, and then implement income generating and wealth building strategies from your lifestyle decision so you can live how you want as explained more in my related post How to Create a Wealth Plan.  

So clarifying your lifestyle choices can help you decide which option strategy is best for you, in the money or out of the money, since in the money covered calls result in fewer positions to manage ongoing, and thus, less time. 

7. Selling Underlying Stocks at a Loss

In the money covered calls require selling call options below a stock’s cost. This can result in selling the underlying stock at a loss as previously addressed as a loss risk factor. Such a sale will happen if the option gets exercised and the strike is below your cost.  

Given this possibility, it’s very important to consider the impact of selling stocks at a loss, especially if you’re using an in the money covered call strategy.

For one, such as sale could trigger tax implications unless the shares are held in a retirement savings account. 

Second, many older investors hold one stock for a long time, often from employment, and they would be devastated emotionally if the stock got sold through a covered call exercise. I’ve seen this situation with some of my financial coaching clients. When an investor wants to minimize the likelihood of an option being exercised, an out of the money covered call makes a lot more sense than an in the money covered call.   

Are In the Money Covered Calls the Best Strategy?

My experience has been that the very first covered call on a new position usually has the best return over ongoing, managed positions. This gives me a bias toward at the money or in the money covered calls since the entire position can be entered into based on the optimal income initially.

Likewise, new covered call trades each month tend to generate more income, easier

On the other hand, managing covered calls is probably a little less work than finding new covered calls to sell every month. This is offset, however, by the reality that managing unexercised covered calls usually doesn’t generate as much income as new monthly covered call trades. 

Income Stream Tip♦  The same stocks can be used for covered call strategies repeatedly, sometimes around dividends or earnings news.

Pros and Cons of In the Money Covered Calls

The chart below summarizes the pros and cons of in the money covered call strategies addressed throughout this article. 

In the Money Covered Call Strategy Pros and Cons 

In the Money Covered Call Pros In the Money Covered Call Cons
Higher Income from Call Options No Capital Gains
More Likely to Be Exercised Time to Find New Positions
More Defensive Strategy May Have to Sell Stock at a Loss
Fewer Positions to Manage  
Higher Investment Capital Turnover  
Lower Stock Basis for Risk Management  

Now that you’ve seen when in the money covered calls are best, the factors to consider before choosing an in the money covered call strategy specifically, and heard about my own experience with in the money covered calls, let’s look at the math with an example.

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 16. Hwanted to generate income from the stock, so he sold 6 June call options with an $18 strike price for $1.40 each 

This gives the call option 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 his brokerage account for the sale of the options, which he gets to keep regardless of what the stock price does. 

Covered Call Income Generated from Retire Corp.  

Here’s the $800 income calculation:  

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

♣  It’s super important to remember that when you write covered calls, particularly in the money covered calls, you know that you may have to sell the stock at a loss unless you roll covered calls you don’t want exercised

Keep in mind, however, that if the stock is sold at a loss, it will be offset by the income generated from selling the call option as explained ahead.  In fact, sometimes I have been happy to sell the stock at a loss because the overall position achieved my income goal from the position. 

Let’s consider two more things that affect the income from this covered call. 

1. How Many Stocks Does One Option Contract Represent? 

Here’s what’s cool: covered call writers get to multiply the option premium by 100 to get the amount of income received. 

This is because 1 option contract equals 100 shares of stock.  

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

2. Costs of Selling Covered Calls

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

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 IRAs or other retirement accounts to eliminate, defer or reduce taxes.   

Now back to Alex and his covered call position on Retire Corp.

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, so let’s look at that next.

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 because it makes the math easy to understand.   

In this case, the option buyer may or may not “exercise” the call option (buy the shares of Retire Corp) since the option strike price is the same as the market price on option expiration. Remember that, either way, Alex kept the $800 from the option sale. 

Note that this turned out to be a very profitable covered call trade for Alex with a stock that decreased in price! 

Next, let’s assume the option buyer did not exercise the option by buying the stock. At this point, Alex has several options you can see below. (Pardon the irresistible pun.) 

Option 1. Sell Another Call Option 

Alex can sell another call option for the next month against his shares in Retire Corp. Note that since the stock price has dropped from his 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 he 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 a deep in the money covered call strategy 

This means if Alex sells another covered call it will probably not be in the money since doing so could generate too much of a stock loss if the option gets exercised.

Remember, the higher income trade off with in the money covered call strategies 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 any covered call investments.

Even after evaluating the potential outcomes, remember that, while charts and information can be used to guide us, no one can know for certain the stock’s price at option expiration since it’s in the future. 

Option 2. Sell a Call Option After Stock Rises 

Instead of selling another call option right after options expiration, Alex can watch the stock chart with the plan to sell a call option near the top of the current trading range to get a higher option premium.  Of course, there is no way to know with certainty that the stock will rise, but the stock chart can be useful information to evaluate the probability. 

Option 3. 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. Rolling out covered calls is a common practice. 

Covered Call Tip ♦  Note that decay of time value that naturally happens with covered call writing is a huge advantage for option sellers vs option buyers 

Option 4. 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 $300 ($.50 per share assuming he sold it at $18 on Monday morning following option expiration) leaving him with a profit of about $500. Of course, a lot can happen over a weekend to affect the price of the stock. For purposes of explanation, we’ll assume an $18 sales price although it will almost certainly be different. 

2. Covered Call Expires In the Money  

In this next possible outcome, assume Retire Corp closes below $18, or deep 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 priceThe option buyer could simply buy the stock for less than the strike price of $18 so there would have been no reason to exercise the option. 

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, which reduces his Retire Corp position cost per share cost to $17.10.  

He would be close to breaking even on the overall position if he sold his stock at option expiration. 

Alex could still use any of the four options available from above but the outcome will be less favorable since the stock price dropped more before the option expiration date.

Let’s look at the third possible outcome at option expiration with Alex’s Retire Corp in the money covered call strategy.

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 he is okay with that since he did the math for all 3 possible option expiration outcomes before choosing an in the money covered call strategy.   

In this case, 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 Overall ITM Covered Call Position: 

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.

In My Experience ♦ I usually enter in the money covered call strategies with the expectation that the stock will temporarily decrease in value. Otherwise, I’d sell an out of the money covered call strategy to try to capture at least some capital gain from the stock.

Keep in mind this is income from one month’s profit from just one in the money 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.  

♦Wealth Building Mindset♦ Always evaluate potential best and worst case investment outcomes, then accept and learn from what occurs.

Annualized Covered Call Return

Using outcome 3 above, 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 in the money covered call strategy was made repeatedly every month throughout the year. That would be impossible since the math changes constantly for both stocks and options. However, 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.

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 received with each call option sold.   

Remember, a lower overall stock cost lowers risk. This lower basis (adjusted stock price) can also serve as a good place for a stop loss to manage investment risk from stocks. I like to assess stop loss placement from a stock chart, as well as fundamentals such as earnings and dividends, while also factoring in the risk I am willing to accept.  

During times of high volatility, for example, I have structured covered calls with a very low risk of about 1% potential loss through the use of stop losses while selling covered calls against a diversified portfolio of ETFs for good income. 

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, and they can be an excellent income source.

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, overall stock market direction, and your own financial goals for building wealth or generating income. 



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DISCLAIMER: Nothing in this post is meant to be taken as personal financial advice. Hire a financial professional if you think you need one. 



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