Covered Call Writing: How to Avoid Being Called Away On Your Shares

One of the first bosses I ever had was a third-generation owner of International Business Machines (IBM) stock.

Naturally he was one of the first people I know to really talk up the benefits of covered call writing.

Writing calls allowed him to take the moderate dividend yield on his shares and turn it into a larger amount of income each year. He was the first to prove that it’s not what you own, it’s how you own it.

Of course, as a third-generation shareholder, he had a large capital gain on shares, and would have a large tax bill if his shares were called away. So, naturally, he had a few tricks to ensure that the shares weren’t called away and would eventually move on to a fourth generation.

For investors getting started with covered call writing, the idea of doubling your income or better on a dividend-paying stock is a great one. But if you don’t want to get called away, there are a few strategies for increasing the odds of holding onto your shares indefinitely.

Sell calls and keep your shares, too

First, you don’t want to sell covered calls when shares are in an uptrend. Some stocks, like IBM, can trade in a range for years, despite periodic good earnings numbers.

The end result? Shares mostly provide investors with returns from dividends. Then, after a few years, shares may move to a much higher range in a short space of time. This is pretty common with blue-chip dividend players.

The trick is to wait until after an uptrend, and only then sell covered calls. If you’ve managed to earn or inherit a large number of shares, you don’t even have to sell calls against your entire position to make a huge difference in income.

Second, you want to find a strike price that’s potentially achievable, but difficult for a company to hit. Say shares of IBM are around $125. A move to $150 would be huge for them, but not entirely out of the realm of possibility. So that may be a good target strike price when selling covered call options.

Finally, you want to be aware of time decay and let it play out in your favor. Options have a time component, and the time decay (or “theta decay”) is what makes selling covered calls so valuable over time.

If you sell an option going out three or four months, you may want to buy it back when there’s a month or so left on the table. By then, most of the time premium will have gone away.

There will be a bit of residual value, but in today’s world of zero-expense trading it’s better to leave some money on the table and walk away. That’s especially true if you don’t want to lose your shares.

So, yes, it’s possible to sell covered calls in a way that greatly reduces the chances of actually losing your shares. Using these guidelines, you can continue to own your shares, collect your dividends and earn some extra money from the position as well.