How to Sell Covered Calls

Selling covered calls on Fidelity is a strategic investment technique that can help you generate additional income on stocks you already own. This strategy is popular among investors who are looking to capitalize on their existing stock holdings by earning premiums from selling call options. If you're interested in selling covered calls on Fidelity, this guide will provide you with a comprehensive understanding of how to execute this strategy effectively.

Understanding Covered Calls

What is a Covered Call?

A covered call is a financial transaction in which an investor holds a long position in an asset and sells call options on the same asset to generate income. This strategy involves two main components: owning the underlying stock and selling a call option on that stock. The call option gives the buyer the right, but not the obligation, to purchase the stock at a predetermined price (strike price) within a specific time frame.

Benefits of Selling Covered Calls

1. Income Generation: By selling call options, you earn premiums which can provide a steady stream of income. This is particularly beneficial in flat or moderately bullish markets.

2. Risk Mitigation: Covered calls can offset potential losses from declining stock prices, as the premium received offers a buffer.

3. Portfolio Diversification: This strategy allows investors to utilize stocks they already own, providing an alternative method of generating returns compared to simply holding stocks for potential appreciation.

Risks Associated with Covered Calls

1. Limited Upside: If the stock's price exceeds the strike price, you'll be obligated to sell the stock at the strike price, potentially missing out on gains.

2. Obligation to Sell: The obligation to sell could result in an unwanted sale if the stock price surges unexpectedly.

3. Income Limitation in Down Markets: If the stock price drops significantly, the premium received might not cover the decline in stock value.

Setting Up an Account on Fidelity

Before you can sell covered calls, you'll need a Fidelity brokerage account configured to trade options. Here’s how to get started:

Steps to Open an Account

1. Visit Fidelity's Website: Go to the official Fidelity Investments website and select the "Open an Account" option.

2. Choose Account Type: Select the brokerage account option, which will allow you to trade stocks and options.

3. Provide Personal Information: Fill out the required fields with your personal information, including your name, address, and Social Security number.

4. Investment Experience: Fidelity will inquire about your investment experience and financial situation to determine your eligibility for options trading.

5. Review and Submit: Carefully review your application and submit it for approval. Once approved, you can proceed to set up your account for option trading.

Enabling Options Trading

Once your account is established, you need to enable options trading:

1. Access Account Settings: Log into your Fidelity account, navigate to the account settings or preferences section.

2. Update Trading Permissions: Find the option for "Trading Options" and apply for the permission to trade covered calls. You might need to fill out an additional form detailing your options trading experience and understanding of the risks involved.

3. Receive Confirmation: After your application is reviewed, Fidelity will send a confirmation when options trading is enabled on your account.

How to Sell Covered Calls on Fidelity

Selecting the Right Stock

1. Own the Stock: Ensure you own the stock on which you intend to sell a call. The number of shares should match or exceed the contract size of the call option (typically 100 shares per contract).

2. Stable or Moderately Bullish Outlook: Choose a stock with a stable or slightly bullish outlook, as covered calls perform best in these conditions.

Step-by-Step Guide to Selling Covered Calls

1. Log Into Your Fidelity Account: Begin by logging into your Fidelity investor account.

2. Navigate to Trade Options: Once logged in, select the "Trade" button on the dashboard. From the trade types, choose "Options."

3. Select Stock and Strike Price: Enter the stock symbol you wish to sell a covered call on. Review the list of available call options and choose a strike price and expiration date that aligns with your strategy.

4. Choosing Strike Price:

   • At-the-Money: Opt for a strike price close to the current stock price for balanced risk and reward.
   • Out-of-the-Money: Choosing a higher strike price may fetch a lower premium but retains more upside potential.

5. Submitting the Order: Complete the trade by indicating the number of contracts you wish to sell. Review your order carefully and submit it.

6. Monitor Your Position: Keep an eye on the stock price and the options market. Be ready to adjust your position if necessary, such as closing the call option before expiration if conditions change.

Tax Implications and Record Keeping

Understanding Tax Responsibilities

Selling covered calls has tax implications that must be considered:

1. Premium Taxes: The premiums you receive from selling calls are generally taxed as short-term capital gains.

2. Stock Sale Taxes: If the call is exercised, and you sell the stock, determine whether any capital gains on the stock's sale apply to short-term or long-term tax rates.

3. End-of-Year Tax Forms: Fidelity provides necessary tax reporting forms (such as 1099) to help you report covered call transactions on your tax return.

Keeping Detailed Records

Maintain comprehensive records of your covered call activities, including:

1. Trade Details: Document trade dates, strike prices, premiums received, and expiration information.

2. Account Statements: Retain monthly brokerage statements from Fidelity that report transaction details.

FAQ Section

What happens if the option expires worthless?

When a covered call expires worthless, you retain the stock and keep the premium received as profit. This outcome is desirable if the stock price does not exceed the strike price.

Can I close a covered call position before expiration?

Yes, you can buy back the call option at any time to close the position before expiration. This might be advantageous if the stock price moves unfavorably or if you need to retain the stock.

What if I want to maintain ownership of my stock?

If maintaining ownership is critical, select higher strike prices or longer expiration periods to reduce the likelihood of exercise.

Does Fidelity charge fees for selling covered calls?

Fidelity may charge a small fee for executing option trades. Check their current pricing schedule or consult with a Fidelity representative for specifics.

Conclusion

Selling covered calls on Fidelity can be an effective strategy to enhance your investment portfolio's income potential. By understanding the process and risks involved, setting up the right account, and following a structured trading strategy, you can use covered calls to meet your financial goals. Always consider consulting a financial advisor to tailor the covered call strategy to your individual circumstances. Stay informed, keep learning, and maximize your investment potential using covered calls.