A Practical Guide to In The Money Covered Calls

An in-the-money covered call is a strategy where you sell a call option with a strike price below the stock's current market price. It’s a conservative move designed to bring in a healthy chunk of immediate income (the premium) rather than shooting for big gains if the stock soars. You're basically trading potential upside for more cash in your pocket today.

What Are In The Money Covered Calls

Think of it like this: you own a house, and you agree to rent it out. That rental income is guaranteed cash flow. You can't suddenly sell the house for a massive profit if the market booms, but you've locked in predictable income. An in-the-money (ITM) covered call applies the same logic to stocks you already own.

With this strategy, you're selling someone the right to buy your shares at a price that’s already lower than what they're worth on the market. To really get a handle on this, it helps to understand the basics of how stock options work. When you sell an ITM call, you're agreeing to a capped sale price in exchange for a bigger upfront payment, known as the premium.

The Mindset Behind the Strategy

So, why would anyone intentionally cap their own profit potential? Simple: the goal isn't huge growth. It's about generating a significant, immediate premium.

That premium acts as both instant income and a cushion if the stock’s price dips, lowering your overall risk. The term "moneyness" is just a way of describing where your strike price sits relative to the stock price. Understanding this is key, and you can dive deeper into what is moneyness in options in our detailed guide here: https://strikeprice.app/blog/what-is-moneyness-in-options.

This conservative strategy really shines for investors who:

• Believe a stock is likely to trade sideways or even drift down a bit.
• Want to generate consistent cash flow from their existing portfolio.
• Have a target selling price in mind and are happy to part with their shares at that level.

The core trade-off with an in-the-money covered call is simple: you sacrifice the potential for large gains in exchange for a higher probability of profit and greater downside protection from the premium collected.

By picking an ITM strike, you get a much larger premium than you would with at-the-money or out-of-the-money calls. That's because the option already has built-in (intrinsic) value, making it more attractive to the buyer. This approach transforms a stock from a simple growth asset into a reliable income-producing machine—a powerful tool for any investor focused on cash flow.

How The Strategy Works Step By Step

Putting an in-the-money covered call into action is pretty straightforward once you get the hang of it. Let's walk through it, cutting out the jargon so you can see exactly how the income gets generated.

The whole thing rests on one simple rule: you have to own at least 100 shares of a stock for every call option contract you plan to sell. This is the “covered” part of the covered call—your shares are the collateral for the option you’re selling.

From there, it’s just a few simple steps.

Executing The Trade

Setting up an in-the-money covered call is a deliberate process aimed at one specific goal: collecting that upfront premium. Here’s the play-by-play:

1. Pick a Strike Price and Expiration: First, you choose a strike price that’s below the stock's current market price. That’s what makes it "in-the-money." You also select an expiration date, which sets the lifespan of the contract.

2. Sell the Call Option: Next, you sell to open one call contract for every 100 shares you hold. The second that trade executes, the premium—your payment for selling the option—lands directly in your brokerage account. That cash is yours to keep, no matter what happens next.

The core trade-off here is simple: you accept a high probability of selling your shares at a set price in exchange for a nice upfront premium. You're choosing immediate income over potential future gains.

Let's ground this in a real-world example to see how the numbers work.

A Practical Example With Apple Inc (AAPL)

Imagine you own 100 shares of Apple, which you bought a while back for $180 per share. The stock is now trading at $200 per share. You think the stock might trade sideways or even dip a bit, so you decide an in-the-money covered call is the right move.

• Current Stock Price: $200
• Your Action: Sell one AAPL call option with a $195 strike price that expires in 30 days.
• Premium Collected: For selling this ITM option, you get an immediate premium of $8 per share, which comes out to $800 total ($8 x 100 shares).

Now, let's look at the two most likely outcomes when the expiration date arrives.

Outcome 1: The Stock Price Stays Above The Strike Price

If AAPL is trading anywhere above $195 at expiration (say, $202), your shares will be "called away," or assigned. This just means you have to sell your 100 shares at the agreed-upon strike price of $195 each.

• Sale of Shares: 100 shares x $195 = $19,500
• Premium Kept: $800
• Total Proceeds: $19,500 + $800 = $20,300
• Total Profit: $20,300 (total proceeds) - $18,000 (your initial cost) = $2,300

In this scenario, you locked in a solid profit. Not bad at all.

Outcome 2: The Stock Price Drops Below The Strike Price

What if AAPL’s price falls below $195 (let's say to $194) by the expiration date? The option expires worthless. The buyer isn't going to exercise their right to buy your shares for $195 when they can get them cheaper on the open market.

• The option contract simply expires, and you keep your 100 AAPL shares.
• You also keep the full $800 premium you collected.
• Bonus: Your cost basis on the shares is now effectively lowered to $172 per share ($180 purchase price - $8 premium).

In either outcome, that premium gives you a clear, tangible win.

Of course, a lot of different factors influence an option's price. If you want to go a level deeper, our guide explaining what are option greeks breaks down the key variables. Understanding them can help you get a much better feel for how your option's value might change over its lifespan.

The Real Benefits Of ITM Covered Calls

When you sell an in-the-money (ITM) covered call, you’re making a deliberate choice. It's a strategic move that puts two specific goals front and center: generating the most income right now and building a solid cushion against a potential drop in the stock’s price.

The biggest draw is easily the higher premium you collect upfront. Since the strike price is already below where the stock is currently trading, the option contract has real, tangible value built right in—what traders call intrinsic value. This makes it far more attractive to a buyer, who in turn pays you a much larger premium compared to at-the-money or out-of-the-money options.

That larger premium leads directly to the second major advantage: superior downside protection. The best way to think about this is to see the premium as a buffer. If the stock stumbles and the price falls, the cash you’ve already collected helps offset that loss, effectively lowering your break-even point on the entire position.

The process is straightforward: you own the stock, sell the call option, and the premium hits your account immediately.

This visual breaks down the simple path of using an ITM covered call to create immediate cash flow from the shares you already own.

Comparing Your Options

To really grasp why an ITM covered call can be so appealing, it helps to see it side-by-side with the alternatives. Ultimately, your choice boils down to what you want to achieve with the trade. Are you hunting for income, hoping for growth, or looking for a little of both?

The trade-off is crystal clear: you are intentionally giving up future growth potential in exchange for a higher probability of profit and a much bigger safety net if the market turns south.

To put this into perspective, let's compare the different "moneyness" options for a hypothetical stock that's currently trading at $100 per share.

ITM vs ATM vs OTM Covered Call Comparison

The table below breaks down how the strike price impacts your premium, protection, and profit potential.

Call Type	Strike Price	Premium Received	Downside Protection	Max Profit Potential
In The Money (ITM)	$95	$7.00 (High)	High	Capped at Strike
At The Money (ATM)	$100	$4.00 (Medium)	Medium	Limited to Strike
Out of The Money (OTM)	$105	$2.00 (Low)	Low	High

As you can see, the ITM option at a $95 strike delivers the largest premium ($7.00), giving you the best defense if the stock price drops. The catch? Your profit is capped, and your shares will almost certainly be called away at expiration. This strategic exchange—swapping growth for security—is the very essence of the ITM covered call approach.

And this isn't just theory. Long-term studies have shown that income-focused strategies like this can really pay off. One piece of research looking at 15 years of market data found that a covered call strategy on the Russell 2000 index actually produced higher returns with lower volatility than just buying and holding the index. It's a powerful reminder of how picking the right strategy, especially when it comes to moneyness, can seriously improve your risk-adjusted returns. For a closer look, you can learn more about the findings on covered call performance.

What's the Catch? Understanding the Risks

While in-the-money covered calls look great on the surface—offering juicy premiums and a bit of a safety net—they come with serious trade-offs. No strategy in the market is a free lunch, and it's critical to know exactly what you're giving up for that high upfront payment.

The biggest drawback is a hard cap on your upside. Plain and simple. If the stock you own suddenly takes off and rallies, your gains are locked in at the strike price. You'll watch from the sidelines as the stock climbs higher, which can be a tough pill to swallow in a bull market. That feeling right there? That's opportunity cost.

Your Shares Are Probably Getting Sold

Another risk you have to be comfortable with is the very high chance your shares will be assigned, or "called away." Think about it: you sold someone the right to buy your stock for a price that's already below its current market value. It's almost a guarantee they'll take that deal.

This creates a couple of potential headaches for you:

• You could lose a stock you love. If you're long-term bullish on a company, this strategy basically forces you to sell it. You might have to part with a core holding you planned to keep for years.
• Hello, tax man. When your shares get sold, it's a taxable event. You'll owe capital gains tax on any profit, which can definitely take a bite out of your returns.

Here's the core dilemma of an in-the-money covered call: Its biggest strength—that high probability of pocketing the premium—is directly tied to its biggest weakness: an equally high probability of selling your shares and capping your gains.

Trading Long-Term Growth for Short-Term Cash

The lure of immediate income can sometimes blind you to the risk of long-term underperformance, especially when the market is climbing. That premium feels like a win today, but consistently putting a ceiling on your gains can cause your portfolio to lag behind over time.

A 2023 study by Roni Israelov and David Ndong confirmed this, finding that while covered call strategies generate cash flow, they often drag down total returns in the long run, particularly in strong bull markets. The research described selling calls as a potential "devil's bargain"—you're trading future growth for cash in your pocket now. You can discover more insights about these findings on covered calls.

To get a handle on the nuances of these types of trades, many investors explore advanced strategies for short option positions. At the end of the day, using an ITM covered call means you've made a conscious choice to prioritize immediate income and downside protection over the chance for big capital gains. It's a strategic move best reserved for when you're feeling neutral or even slightly bearish about a stock's prospects.

When To Use This Income Strategy

Knowing when to use a strategy is just as important as knowing how. An in-the-money covered call isn’t a one-size-fits-all tool; it’s a specific play for certain market conditions and personal goals. Timing it right can turn a good trade into a great one.

The sweet spot for this strategy is when you have a neutral or slightly bearish short-term outlook on a stock you already own. You aren’t predicting a crash, but you don't see it ripping higher anytime soon, either. In that kind of environment, the rich premium from an ITM call creates a fantastic income stream while the stock price chops around or drifts lower.

This strategy really shines because it’s built to perform well in flat or falling markets—exactly when many other approaches stumble. The income you can generate is often several times higher than a stock's dividend, giving you a steady cash flow that's driven more by market volatility than by the stock actually going up.

Locking In Your Exit Price

Here’s another perfect use case: you’ve already decided to sell a stock once it hits a certain price. Instead of just placing a limit order and waiting, selling an in-the-money covered call lets you get paid for your patience.

Think of it as pre-selling your stock. You name your price (the strike price), and another investor pays you a premium today for the right to buy it from you later.

This is a powerful way to take profits. You not only hit your target selling price but also pocket the option premium on top of it, squeezing every last drop of return from the position. Understanding when to sell covered calls is a core skill, and this scenario is a textbook example of smart timing.

When To Avoid This Strategy

Just as critical is knowing when to keep this tool in the box. An in-the-money covered call is absolutely the wrong move in a few key situations:

• During a Strong Bull Market: If you think the market or your stock is about to take off, this strategy will put a hard ceiling on your gains. You'll be forced to sell your shares right as they're starting to fly, missing out on all that upside.
• On Long-Term Core Holdings: Never use this on a stock you believe in for the long haul—the ones you plan to hold for years. The high probability of assignment means you'll almost certainly be forced to sell a valuable asset you wanted to keep.

At the end of the day, this strategy is for generating income and executing planned exits. It’s not for growth. Aligning its use with a neutral or slightly defensive market view is the key to making it work for you.

A Practical Checklist For Getting Started

Before you jump into your first in-the-money covered call, it pays to run through a quick pre-trade checklist. This isn't about getting bogged down in complex analysis. Think of it as a simple, repeatable process to make sure every trade aligns with your income goals and what you're comfortable risking.

It all starts with picking the right underlying stock. You’re looking for shares that are relatively stable and highly liquid. "Liquid" just means there are plenty of buyers and sellers for both the stock and its options, so you can get in and out of trades easily without getting burned by weird price swings caused by low volume.

Fine-Tuning Your Trade

Once you’ve zeroed in on a good stock, it’s time to structure the trade itself. This is where you’ll need to be deliberate about picking your strike price and expiration date. Each decision directly shapes how much income you can make and the odds of your shares getting called away.

A great starting point is to focus on these key elements:

• Strike Price Selection: Choosing a strike deeper in the money means you’ll collect a bigger premium upfront and get more downside protection. The trade-off? Assignment is almost a sure thing. You need to balance your hunger for a fat premium against your willingness to actually sell your shares at that price.
• Expiration Date: Shorter-term options, like those 30-45 days out, give you more chances to collect income but demand more hands-on management. Going with longer-term options nets you a larger initial premium but locks you into the position longer, exposing you to more market shenanigans over time.
• Position Management: Have a game plan before you place the trade. What will you do if the stock drops? Are you okay holding it? If it rockets up, are you fine with the capped gain? Decide ahead of time whether you'll let the shares be assigned or if you plan to "roll" the position to keep it going.

Rolling is a common technique where you buy back the call you sold and immediately sell a new one with a later expiration date. It lets you keep the income stream flowing and potentially adjust your strike, but it can also mean extending a trade that isn't working out.

By walking through this checklist every time, you turn what could be a speculative gamble into a calculated income strategy. It ensures every in-the-money covered call you write is a thoughtful move, not just a gut reaction to whatever the market is doing that day.

Frequently Asked Questions

Even when you've got a handle on the strategy, a few specific questions always pop up. Here are some quick, straightforward answers to the most common ones I hear about in-the-money covered calls.

What Happens If The Stock Price Drops Significantly?

If the stock tanks and falls below your break-even point (your cost basis minus the premium you pocketed), you'll be sitting on an unrealized loss. The good news is that the fat premium from an in-the-money covered call gives you a pretty substantial cushion against a drop.

In this scenario, the option simply expires worthless. You get to keep the entire premium and all of your shares. From there, you can just turn around and sell another covered call to bring in more cash and lower your cost basis even further.

Can I Use This Strategy On Dividend Stocks?

Absolutely, but you need to be on high alert for early assignment. An option holder might decide to exercise their right to buy your shares early—specifically, right before the ex-dividend date—so they can snag that upcoming dividend for themselves.

This is most likely to happen with deep in-the-money calls where the dividend payment is worth more than the option's remaining time value. If you get assigned early, you kiss that dividend goodbye.

It comes down to a simple calculation: is the premium you're collecting worth more than the dividend you might have to forfeit?

How Do Taxes Work With This Strategy?

Taxes are a huge piece of the puzzle, so don't overlook them. If your shares get called away, that's a taxable event. You'll realize a capital gain or loss based on your stock's original purchase price and the strike price, with the premium you collected getting baked into the final sale price.

If the option expires worthless, that premium is usually taxed as a short-term capital gain. Tax laws can get tricky, so it's always a smart move to chat with a tax professional to make sure you understand exactly where you stand.

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