Covered calls feel safe but encourage poor behavior: emotional holding, market timing, and hidden tax traps.
Sectors & Industries
June 28, 2025
Table of Contents
When I first heard about covered calls, they sounded like free money. "Generate income from stocks you already own!" the headlines proclaimed. "Turn your boring blue chips into cash machines!"
But after years of trading and watching countless investors get burned by this supposedly "safe" strategy, I've come to a different conclusion: covered calls are often a wealth destroyer disguised as a conservative income play.
Before we dive into why they're problematic, let's get clear on what we're talking about. A covered call involves:
On paper, it sounds perfect. In practice, it's a different story.
The biggest issue with covered calls isn't what you gain; it's what you give up. When you sell that call option, you're literally selling your right to profit beyond a certain point.
Think about it this way: if you truly believe a stock will outperform, why would you cap your gains? And if you don't believe it will outperform, why own it at all?
My painful lesson came with Apple during the 2020–2021 rally. I bought 500 shares around $125 in mid-2020 and started writing covered calls with $135 strikes to “juice” a little extra income. Those calls looked harmless, until Apple marched relentlessly higher and closed above $180 in December 2021. My shares were assigned at $135, I pocketed a few modest premiums, and in exchange I left well over $20 k in upside on the table. That’s when I realized the real cost of capping your winners.
Here's what the covered call cheerleaders don't tell you: equity markets trend upward over time. By systematically capping your gains, you're fighting against one of the most powerful forces in investing.
Let's run some numbers. If you're collecting 2-3% per month in premium (which is optimistic), you're making maybe 24-36% annually. Sounds great, right? But consider this: the S&P 500 has returned about 10% annually over the long term, with individual years often seeing 20%+ gains.
When you sell covered calls, you're trading the potential for those big up years for a steady but limited income stream. It's like selling lottery tickets instead of buying them; except in the stock market, the house edge favors the long-term holder, not the option seller.
Nobody talks about this enough, but covered calls can create a tax nightmare. When your shares get called away, that's a taxable event. If you've held the stock for less than a year, you're looking at short-term capital gains rates, which can be brutal.
Even worse, if you've been collecting dividends on those shares, losing them to assignment means losing that income stream. You might find yourself scrambling to replace both the capital gains and dividend income you just lost.
Covered calls seem to encourage all the wrong behaviors:
Emotional attachment to mediocre stocks: Because you're generating income, you might hold onto stocks that aren't performing well fundamentally.
Timing the market: You're essentially betting that your stock won't have a big move up, which requires market timing skills most of us don't have.
False sense of security: The premium income can mask the fact that your underlying stock is declining in value.
The irony is that these are behaviors you'd never engage in as a responsible investor under normal circumstances. But because they're wrapped up in the seemingly sophisticated "covered calls strategy," you end up making these poor decisions without realizing it.
I'm not saying covered calls are always wrong, but the circumstances where they make sense are much narrower than most people think:
Even then, you might be better off just selling the stock and investing in something with better prospects.
If you've been attracted to covered calls for the income component, here are three strategies that might serve you better:
If you're drawn to covered calls for income, consider dividend-focused ETFs like VYM, SCHD, or NOBL. These funds provide steady dividend income without the operational complexity and risk of covered calls.
Benefits:
Best for: Investors who want steady income without active management.
Instead of trying to manufacture income through covered calls, event-driven trading focuses on identifying stocks experiencing catalysts that historically drive significant price movements. Rather than capping your upside, you're positioning for potential gains based on actual corporate developments.
This approach involves tracking events like insider buying, share buybacks, earnings surprises, and leadership changes—the types of developments that often create the price movements investors are seeking. By focusing on these fundamental catalysts, you avoid the artificial profit limitations that come with covered call strategies.
Key Benefits:
Getting Started: While you can track these events manually through SEC filings and news sources, platforms like LevelFields AI make this approach much more accessible by automatically detecting over 27 types of market-moving events and providing the backtested data to evaluate each opportunity in a data-driven manner.
Best for: Active investors who want to base decisions on fundamental catalysts rather than manufactured income strategies.
Real Estate Investment Trusts (REITs) and Dividend Aristocrats offer attractive yields while maintaining upside potential. Unlike covered calls, these investments aren't artificially capped.
Benefits:
Best for: Income investors who want to "set it and forget it."
Using AI trading tools can help find the best entry and exit points for options trades and for selling covered puts. Such tools identify bearish or bullish opportunities happening all the time that are highly likely to impact stock option pricing. Historical data sets can help determine the best strike price and expiration date for selling covered puts, buying puts, selling calls, selling covered calls, and buying naked calls.
Ready to transform the way you trade? With LevelFields, you gain access to cutting-edge analytics that empower you to find better investments 1,800 times faster.
Our platform analyzes over 1.8 million market events each month, ensuring you act on facts, not opinions. Don’t leave your trading decisions to chance—equip yourself with the tools to make informed, data-driven investments.
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Covered calls feel like a sophisticated strategy, but they're often just a way to turn potentially great returns into mediocre ones. The income they generate is usually more than offset by the upside you're giving away.
If you're looking for income, there are better ways to get it. If you're looking for growth, covered calls are actively working against you. And if you're looking for both, you're probably better off with a diversified portfolio of quality dividend stocks or dividend-focused ETFs.
The market rewards patient investors who let their winners run. Covered calls do the opposite: they systematically cut your winners short. Unless you have a very specific reason for using them, your portfolio will likely perform better without them.
Remember: in investing, sometimes the best strategy is the one that doesn't artificially limit your upside. Let your winners run, cut your losers short, and resist the temptation of strategies that promise easy money but deliver mediocre results.
Covered calls aren’t inherently bad for stocks, but they can limit potential upside. If the stock price rises sharply, gains are capped at the strike price of the call sold. This strategy sacrifices growth in exchange for short-term income, which may not align with long-term investment goals.
Covered calls may not be ideal in strongly bullish markets, as they limit upside potential. They're also less effective on volatile stocks, where the risk of assignment is higher and pricing can be unpredictable. Additionally, if the stock drops significantly, the premium earned won't offset the loss.
Covered call funds carry risks such as:
The biggest risk is missing out on large stock gains. If the stock price surges past the strike price, your shares may be called away at a lower price, meaning you forfeit potential profits. You also still bear the downside risk if the stock falls.
Yes, you can lose money. While the premium collected offers some downside protection, if the stock drops significantly, the loss on the underlying shares can outweigh the income received from selling the call.
Buying calls is risky because they are time-sensitive assets. If the stock doesn't rise above the strike price before expiration, the call can expire worthless, resulting in a total loss of the premium paid. Additionally, implied volatility and poor timing can work against buyers.
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