Pros
- You can profit from a stock position that may not pay dividends.
- Considerably low risk since your short call is protected with your stock position
- One must buy the stock before selling for this strategy to be efficient. In retrospect, the process is relatively easy to set up.
- It's a good way to hedge by providing some compensation.
- Endless recyclability. If your contract expires worthless, you can make the call again and again since you retain the shares anyway.
Cons
- You are making a relatively small chunk of profit with covered calls but you must also bear the downside. This includes both if the stock goes up or down.
- There's a good chance you are bullish if you own the stock in the first place, which you need to trade until the expiration of the call. If the price rises, you will lose the gain you could've made if hadn't sold the stocks.
- This is a big one! Your stocks will be locked behind the contract until it expires. If ever an opportunity arises where you may need to sell the stock, you'd be in a fix. Although you could repurchase the call and sell the stocks.
- With covered calls you need more capital up front.
- If you are concerned about taxable income, you may need to tread carefully. Successful covered calls generates taxable income. Moreover, there may be additional tax liability to account for if there was a capital gain on the stock.
Hope this helps. Happy investing!