Generating Passive Income Using Covered Calls Generating Passive Income Using Covered Calls Generating Passive Income Using Covered Calls

Generating Passive Income Using Covered Calls

Danny Khoo

Singapore Sales Trader

What is a covered call?
A covered call is an option strategy that involves selling  call options against a stock that you already own. As you own the stock, the risk of delivering the shares if the option expires in the money is covered. At the same time, the seller of the call option will generate some passive income (premium) in the process of selling the covered call. This is considered to be a lower risk option strategy as the risk of unlimited loss is capped. Typically the professional traders tend to sell calls against a portion of their holdings at one time so that they can participate on the upside on the remaining holdings or have the opportunity to sell more calls at a higher strike if the stock price goes up further.

How does this work?
Selling covered calls is a popular strategy for traders who hold equities over the medium to long term. Typically, selling calls are risky as it exposes a trader to unlimited losses if the underlying stock price goes up above the strike price. However, if a trader already owns the underlying stock, the losses can be limited by simply delivering the stock to the option buyer upon expiry or when the option buyer exercises.

What happens at the expiration of the covered call option?
1. If stock price > strike price on the expiration day, the option is in the money (ITM) and therefore the seller of the option is obligated to deliver the stocks to the buyer of the option. When you own the shares in your portfolio, they get offset against the option expiring in the money. As an option seller, you get to keep the premium and the option buyer gets the stock at the strike price of the option. Some traders like to think of it as a pre-agreed cap on profit on the stock in exchange for a premium.

If stock price < strike price, the option is out of the money (OTM) and there is no obligation for the option seller to deliver the stock to the buyer of the option. The option expires worthless for the buyer and the seller gets to keep the premium.

For example:
Let’s say you own 1000 shares of stock A at $30 and current price is $35.

If you feel comfortable selling stock A at $40 if it gets to that price, you can place an order to sell 10 call options at strike 40 expiring in a month’s time (For US shares, each lot of call option represents 100 shares of the underlying). Let’s assume this is trading at about $0.70. As a result, you will receive premium for 10 call options x 100 shares x $0.70 = $700

Scenario analysis:

Goes above $40
You sell your 1000 shares of stock A at $40, making a profit of $10 per share. Total gain = your premium received ($700) + your profit ($10 x 1000 = $10,000) 
 Does not go to $40Total gain = your premium received ($700) from selling 10 call options at $40 strike. There is no obligation to sell your shares to call option buyer.

When are the best times to trade covered calls?
The best time to trade covered calls is in a sideways or down trending market where you can generate good income from premiums while holding onto your long equity portfolio. In a strong uptrend, it might be less optimal to sell covered calls and give up further upside potential for a relatively small premium. If you wish to do so, it might make sense to do it in multiple tranches – instead of selling 10 lots of calls at once, you can stagger into 5 batches of 2 lots and sell on the way up. The other important input to consider is the implied volatility of the option – the higher the implied volatility, the greater the premium for the option.

Key advantages of covered calls
1. Generates passive income. Selling a covered call generates an income via premiums that can supplement the overall return of a portfolio.

Relatively low risk. As the risk of being short a call is covered with your stock position, this is a relatively low risk way to trade options.

No extra margin required to sell covered calls. As you hold the underlying stock for delivery, there is no extra margin required to sell the same number of covered calls at Saxo.

Risks of trading covered calls
1. Capping your stock’s upside potential. One key risk is the loss of opportunity to profit from your stock’s potential upside above the call option’s strike price.

Risk of using covered calls as a proxy for take profit orders: In the example above, it is possible that the stock trades well above 40 through the course of the option but on expiry falls back below 35. Without the option, the stock holder might have booked the profit at 40 but because the stock was covered by call options, the stock holder might have waited out until expiry.

Key points to note when trading covered calls against CFDs:
1. To enjoy a margin offset for selling covered calls, you will need to own the underlying shares. Selling calls against CFDs would still incur additional margin for the option.

It is important to note that CFD holdings cannot be delivered to the call option buyer if the option expires in the money.

One of the alternatives for CFD holders is to replace the CFD with stock (sell CFD, buy stock) closer to the expiry date if the option is likely to expire in the money.

Scenario analysis on expiry of the option:

Selling against the full holdings of 1000 shares
Selling against half the holdings of 500 shares


The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (
Full disclaimer (

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region


Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.