I would have thought that there was no downside risk. There is an opportunity cost if you have your shares called from you during a rally. However, if you are planning on holding the shares long term, I don't see any additional downside risk of selling a call against them. I'm not advocating for selling covered calls, i just want to make i have a proper understanding of the risk profile. Thanks
The only actual loss, given that you sell an OTM call, is the opportunity cost of missing out on a rally. It's my personal biggest fear with selling CC, and I think you'll find it's everybody else biggest fear here as well.
There are other ways of thinking about that though.
One is that if you need cash, but you don't need it immediately, and are ready to sell shares to raise that cash; then a covered call on those shares might be a mechanism to raise some cash immediately, and possibly sell the shares later. Example - if you're ready to sell shares today at $640 but don't need a big whack of cash immediately, then you're probably also willing to sell the shares for $700 in a month if that opportunity arose.
In this case, there won't be an opportunity cost - if the shares go past $700 by expiration, you get the premium plus a $700 sale price when you were ready to sell at $640. I think of this as a pre-sale of shares you're ready (or getting ready) to sell anyway. For those still in growth mode (as I've been for the last 8 years, but no longer as of the last few months), the risk of losing out on that upside is maybe too high. Tesla has twice gone on 6x or so runs in the last 8 years - missing out on one of those would hurt.
The risk to this pre-sale is the shares go down to $500 (or something). In this case you keep the premium, but now you need to raise cash and the shares are down $140.
There is another reason to sell calls (and puts). Once you're in an income and growth mindset, then the risk to your living expenses of a big drop in the share price becomes something you might want to mitigate. In this case, selling covered calls generates income you need immediately at the risk of your shares being called away later. If you have a big enough pile of shares, then that problem of shares called away comes with an even bigger portfolio to fund your portfolio.
An example for me - I've got enough to retire. To offset risk of loss, I'm selling covered calls at a level that if called away during an epic run, I'll miss out on a lot of that run. I sold some $4200 pre-split / 840s post-split for example, with a 2 year expiration - collected about $130 in premium. That's still more than 50% away at today's share price. I am increasingly feeling like those will be ITM at expiration.
But I'll be more than ok - I've had cash in the meantime for expenses (and selling puts). The outcomes might be: the shares might not be above $840 at expire time (keep the premium!); I might have an early close opportunity where I keep most of that $130/share premium, and even if they do get called away, then I've still doubled that particular position (actually ~tripled from when I opened). And without that gain or premium, I was at "enough" before the sale, and end up with even more than enough. (Do you know what "enough" is for you?)
And by selling that call, I've offset risk to the downside. From when I opened the position, I'll be even down to around $300 or a little lower (with an early close opportunity should the shares fall that far). If necessary that one position will provide 1-2 years of living expenses, and if called away, the profits when the shares are sold at $840 sale will generate another 3-5 years of living expenses.
In a big drop scenario, I'll still see my portfolio shrink, but the premium will buy me a year or two for the shares to recover. This is the difference between income and growth, and growth (at least as I see it). Before this summer, I'd just have held the shares and mostly been ignorant of the current price rally.
Also be aware - part of why I'm pursuing this approach to income, is that my wife and I are not yet emotionally ready to part with any of our shares, at least on a straight sale basis as we go along to raise living expenses. We're ready to pre-sell at a very high strike (I have 840s and 900s right now). If we were ready to sell shares as needed, then there is a reasonably good chance that we could do much better just owning shares. But we aren't, today, and I prefer to work with my emotions rather than trying to logic my way out of them; I'm reasonably confident this will change in the future (maybe when the shares are at $10,000
).
Context matters deeply, and we each need to understand our own context.
