By Cap Puckhaber, Reno, Nevada
I’m Cap Puckhaber, a marketing professional, amateur investor, part-time blogger, and outdoor enthusiast. Today on SimpleFinanceBlog.com, we break down the covered call strategy, a powerful method for generating income and lowering risk in your investment portfolio. We’ll explore how selling covered calls works, look at the pros and cons, dive into popular ETFs like JEPI that do the work for you, and even touch on the tax implications. This is a complete guide to help you understand if this approach is right for your financial goals.
So, What Exactly Is a Covered Call?
When I first heard the term “covered call,” it sounded like Wall Street jargon meant to confuse people. It’s actually much simpler than it sounds. A covered call is an options strategy where you sell someone the right, but not the requirement, to purchase a stock you already own, at a set price, within a specific timeframe. The key here is that you must own at least 100 shares of the stock for every one call option contract you sell. That’s what makes the call “covered.”
Think of it this way. Imagine you own a classic car valued at around $50,000. You don’t think its value will shoot up dramatically in the next month, but you wouldn’t mind selling it for $52,000. A collector comes along and says, “I might want to buy your car for $52,000 next month, but I’m not sure yet.” You could make an agreement and tell them, “Pay me $500 today, and I’ll guarantee you the right to buy my car for $52,000 anytime in the next 30 days.”
You immediately get $500 in your pocket. If the collector decides not to buy, you keep the $500 and your car. If they decide to buy, you sell the car for $52,000 and still keep the $500 you were paid upfront. You just traded the potential for the car’s price to hit $60,000 for the certainty of getting paid something today. That payment is called the “premium,” and in the stock market, that’s the income you generate from selling a covered call.
Why I Personally Chose Covered Calls
For me, it all came down to a desire for more income. I always liked the idea of dividends, but the quarterly checks from my blue-chip stocks felt small and infrequent. Worse, some of my favorite long-term growth stocks paid almost no dividend at all. I started looking for a way to create my own “dividends” on a monthly basis. That’s when I discovered covered calls. This strategy gave me a way to turn my non-dividend or low-dividend stocks into income-producing machines. It felt like I was putting my lazy assets to work, generating a consistent cash flow that I could control, month in and month out.
The Two Paths: DIY Calls vs. Covered Call ETFs
When it comes to using this strategy, you have two main choices. You can either manage the process yourself or you can buy a managed fund that does all the work for you. Understanding the manual process is important because it’s the foundation of how these funds work.
The DIY Method: Selecting a Strike Price and Expiration
Putting this strategy into action yourself involves a few key decisions. The first step is ensuring you have the right foundation, which means owning at least 100 shares of the underlying stock. This is why the strategy works best with companies you are comfortable holding long-term. After that, you have to choose a strike price and expiration date.
- Strike Price: This is the price per share you agree to sell at. A strike price close to the current stock price will earn you a higher premium but increases the chance of your stock being sold. A price further away earns less premium but gives your stock more room to grow. For a beginner, this is the trickiest part; you are constantly balancing immediate income against potential future gains.
- Expiration Date: This is when the contract ends. Most traders choose dates 30 to 45 days out. This timeframe offers decent premiums and allows you to reassess your position monthly. Shorter dates mean less premium, while longer dates lock you in for too long.
The “Easy Button”: Let a Covered Call ETF Do the Work
If choosing strike prices and expirations sounds like a lot of homework, you’re not alone. It can be complex and time-consuming. That’s why for many investors, especially beginners, the simpler path is through covered call ETFs. These are funds managed by professionals who handle the entire covered call process for you.
These ETFs hold a basket of stocks and systematically sell call options on them to generate income, which they then pass on to you as a monthly dividend. You get the benefit of the strategy without any of the hands-on management. Some of the most popular options include:
JPMorgan Equity Premium Income ETF (JEPI)
This is an actively managed fund. It holds a portfolio of defensive, high-quality, dividend-paying stocks from the S&P 500. To generate extra income, it doesn’t sell calls on its own stocks. Instead, it uses Equity-Linked Notes (ELNs), which are special debt instruments that provide the returns of a covered call strategy on the S&P 500. This unique structure aims to provide significant monthly income while capturing some stock market upside with less volatility. You can see its latest performance and holdings on financial sites like Yahoo Finance.
JPMorgan Nasdaq Equity Premium Income ETF (JEPQ)
This is JEPI’s sibling, but it focuses on the tech-heavy Nasdaq-100 index. It follows a similar strategy of holding a portfolio of stocks and using ELNs to generate income from a covered call strategy on the Nasdaq-100. It’s for investors who want income but also want exposure to the growth potential of the technology sector.
Global X ETFs (QYLD, XYLD)
The Global X family offers popular covered call ETFs. QYLD tracks the Nasdaq-100 and sells calls against the entire index, known for providing a very high, though less stable, monthly dividend. XYLD does the same thing but for the S&P 500. These funds are more passive and formulaic than JEPI or JEPQ.
| Feature | JEPI (S&P 500 Focus) | JEPQ (Nasdaq-100 Focus) | QYLD (Nasdaq-100 Focus) |
| Strategy | Actively managed stocks + ELNs | Actively managed stocks + ELNs | Sells at-the-money index calls |
| Expense Ratio | ~0.35% | ~0.35% | ~0.60% |
| Income Goal | High monthly income with low volatility | High monthly income with tech exposure | Maximize monthly income |
| Best For | Conservative income investors | Income investors wanting tech growth | Pure income seekers |
Expense ratios and yields are approximate and subject to change.
My Real-World Experience with JEPI and JEPQ
I’ve been using JEPI and JEPQ for income myself. I appreciate the core idea behind them: I know my upside is limited, but my downside is also slightly cushioned by the monthly distributions. It feels like a more stable way to stay invested.
However, it’s not a perfect system. Lately, with the tech sector being so hot through 2024 and into 2025, JEPI has underperformed the broader S&P 500. A covered call strategy inherently caps gains, so in a strong bull market, these funds will lag. This market environment has also impacted the income. Because the fund’s income is partly derived from option premiums, which fluctuate with market volatility, both JEPI’s and JEPQ’s dividend distributions went down this past quarter. It’s a real-world reminder that there are always trade-offs.
A Deeper Look at the Risks
It’s critical to go into this strategy with both eyes open. While we’ve touched on the main risks, let’s break them down further.
- Underlying Stock Risk: This is the biggest one. A covered call does not protect you from a stock market crash. If you own 100 shares of a stock at $100 ($10,000 value) and it plummets to $60 ($6,000 value), a $200 premium from a covered call won’t make you feel much better. You’ve still suffered a $3,800 loss. Only use this strategy on stocks you’d be happy to own even if they fell 20%.
- Capped Upside Potential (Opportunity Cost): This is the fundamental trade-off. In a roaring bull market, you will underperform. Seeing a stock you sold at $110 soar to $150 can be painful. You made a profit, but you missed out on a much larger one.
- Early Assignment Risk: While options are usually exercised at expiration, they can be exercised by the buyer at any time. This happens most often right before an ex-dividend date. The buyer may exercise their call option to capture the upcoming dividend for themselves. This can mess up your plan if you intended to hold the shares through the dividend payment.
- Complex Tax Situations: The income and gains from options strategies can complicate your taxes. We’ll discuss this more next, but keeping detailed records is essential to avoid headaches when filing.
Understanding the Tax Implications
Taxes are an unavoidable part of investing, and covered calls have their own specific rules. For a complete understanding, you should always consult a tax professional, but here are the basics every investor should know.
The premium you receive for selling a call option is almost always taxed as a short-term capital gain. This means it’s taxed at your ordinary income tax rate, which is higher than the long-term capital gains rate. This is true regardless of how long you’ve held the underlying stock. Think of the premium as immediate income.
When your shares get called away (assigned), the tax treatment depends on how long you held the stock.
- If you held the shares for more than one year, your profit on the stock sale is taxed as a long-term capital gain.
- If you held the shares for one year or less, your profit is taxed as a short-term capital gain.
This is why tracking your purchase dates and cost basis is so important. A profitable trade can become less attractive after you account for a higher tax bill. Covered call ETFs like JEPI simplify this, as their distributions are categorized for you on a 1099-DIV form at the end of the year.
Is This Strategy Right for You? A Checklist
Deciding if covered calls fit your investment style requires an honest self-assessment. This isn’t a one-size-fits-all strategy. Ask yourself these four questions to determine if it aligns with your goals.
- What’s Your Primary Investment Goal? Are you laser-focused on maximizing growth and achieving the highest possible capital gains? Or is your main priority generating a consistent, predictable stream of income to supplement your salary or fund your retirement? If income is your primary answer, covered calls are a strong contender. If growth is everything, you might find the capped upside too restrictive.
- How Do You Feel About Missing Out (FOMO)? Imagine you sell a covered call on a stock at a $110 strike price, and a week later, the company announces a breakthrough, sending the stock to $150. You’d be forced to sell at $110. If that scenario would cause you significant regret, this strategy might not be for your mental well-being. But if you’d be happy with your planned profit and move on, you have the right temperament.
- How Hands-On Do You Want to Be? Do you enjoy analyzing charts, tracking volatility, and actively managing your positions every month? If so, the DIY approach might be rewarding. If you prefer a more passive, “set it and forget it” approach to investing, then a covered call ETF like JEPI or QYLD is almost certainly the better path.
- What Is Your Outlook on the Market? Covered call strategies tend to shine in flat, sideways, or slightly rising markets. In these conditions, you collect premiums while stock prices don’t run away from you. They tend to underperform significantly in raging bull markets and still lose money (though slightly less) in sharp bear markets. Your market outlook can help determine if now is a good time to implement this strategy.
What Happens Next? A Look at the “Wheel” Strategy
For those who choose the DIY path, a common question is: “What do I do after my shares get called away?” This often leads investors to discover “The Wheel,” a strategy that is the logical next step. For a technical deep dive into these kinds of options strategies, Investopedia offers excellent guides and is a valuable resource.
The Wheel is a cyclical strategy that combines selling covered calls with selling cash-secured puts. Here’s how it works in a nutshell:
- Sell a Cash-Secured Put: You start by selling a put option on a stock you want to own, at a strike price you’re willing to pay. You collect a premium for this.
- Two Outcomes for the Put: If the stock stays above the strike, the put expires worthless, you keep the premium, and you repeat step 1. If the stock falls below the strike, you are assigned the shares—buying 100 shares at your desired price.
- Sell a Covered Call: Now that you own 100 shares, you begin selling covered calls against them, as we’ve discussed. You collect premiums.
- Two Outcomes for the Call: If the call expires worthless, you keep the premium and your shares, and you repeat step 3. If the stock gets called away, you sell your shares for a profit, keep the premium, and go back to step 1 to start the “wheel” all over again.
It’s a continuous loop of generating income from both sides of the options market. It’s more active than just selling covered calls, but it’s a popular way to systematically generate income and acquire stocks at a discount.
Final Thoughts
Learning to use covered calls—both manually and through ETFs—fundamentally changed how I think about my portfolio. It shifted my focus from just chasing capital appreciation to also valuing consistent income generation and risk management. It’s a tool, not a magic bullet. It won’t make you rich overnight, but it can help you build a more resilient and productive portfolio over the long run. There are clear trade-offs, particularly the capped upside, but for an investor focused on cash flow, it’s one of the most effective strategies out there.
If you’re curious, my advice is to start small. Don’t go all-in right away. Consider buying a small position in an ETF like JEPI to see how it feels and performs. Or, if you’re feeling adventurous, try paper trading the DIY strategy on a stock you know well. Track your results, learn from the experience, and see if it aligns with your financial journey.
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AAbout the Author: Cap Puckhaber
Cap Puckhaber is a seasoned marketing strategist and expert finance writer with over two decades of experience in the industry. He specializes in creating actionable content that demystifies personal finance, investing, and market trends. His work provides honest, real-world advice to help readers achieve their financial goals. When he isn’t analyzing market data, he is an avid outdoor enthusiast. Cap shares his expertise across several platforms, including his personal and business development blog, his marketing agency, Black Diamond Marketing Solutions, and his Simple Finance Blog. He also documents his adventures at The Hiking Adventures.
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