Here’s a hard truth: not every investor succeeds at building a profitable portfolio. Sometimes it’s the market’s unpredictability, but more often it’s because newer investors lack a clear strategy. In short, they don’t know how to navigate the pitfalls of the market.
One of the reasons we recommend option trading – more specifically, selling covered calls – is because it reduces risk.
Done correctly, this strategy makes it possible to generate income whether stocks move up, down, or sideways. It also gives you flexibility to cut losses, protect your capital, and maintain control over your stock without requiring a huge cash investment.
But caution is still essential. Even seasoned traders can misjudge an opportunity and lose money.
That’s why we’ve pulled together the five most common mistakes to avoid when selling covered calls. Steering clear of these errors can put you on a much stronger path to success.
Mistake #1: Selling at the Wrong Strike Price or Expiration
In options trading, strategy is everything. A frequent misstep is choosing the wrong strike price or expiration date without fully understanding the trade-offs.
The strike price is the price at which a call can be exercised, and it has a major impact on profitability. When setting it, consider both your risk tolerance and your desired payoff.
Take this example: you buy 100 shares of a stock at $50 and sell a call with a $50 strike. You might collect a $2 premium per share ($200 total). After factoring in that premium, your effective cost per share is $48.
If the stock drops to $48, the option expires worthless and you keep the $200. If the stock rises above $50 at expiration, your shares may be “called away”—but you still keep the premium.
- Out-of-the-Money (OTM) calls (strike above market price) offer less premium but lower risk of being called away.
- In-the-Money (ITM) calls (strike below market price) provide more premium but higher odds of losing the shares.
Expiration is equally important. Today, many stocks have weekly, monthly, quarterly, and annual options. While longer-dated contracts pay higher premiums, shorter-term options usually benefit sellers more because of time decay.
Mistake #2: Selling Naked Calls Instead of Covered Calls
When it comes to selling covered calls, the premium is the maximum profit you can receive (in our above example, $200 was the premium and highest potential payout).
If the underlying asset increases significantly in price, the investor may face large losses if they don’t own the shares. This is why most option writers have a position in the underlying asset as well, meaning that they also own the stock and are not just writing options on a stock they don’t own.
Owning the stock you are writing an option on is called writing a covered call. If you don’t own the stock or underlying security, it is called writing a naked call.
A naked call strategy is inherently risky, as there is limited upside potential and a nearly unlimited downside potential should the trade go against you.
Investors may even be forced to purchase shares on the asset prior to expiration if the margin thresholds are breached. Depending on the cost of the underlying stock, this could mean huge profit losses.
As a result of the risk involved, new investors should focus on selling covered calls on stocks they either already own, or wouldn’t mind owning (and have the capital to purchase).
Mistake #3: Forgetting About Dividends
When it comes to evaluating option prices, you want to make sure you take dividends into account before selecting the right stock.
If you purchased 100 shares, you would receive dividend payments if the ex-date is between the time of purchase and expiration, in addition to any premium you might receive by selling a call.
Dividend payments prior to expiration will impact the call premium. Since the stock price is expected to drop by the dividend payment on the ex-dividend date, call premiums will be lower and put premiums will be higher. Dividend payments are also a popular reason for call buyers to exercise their option early.
Dividends still play a major role in long-term returns. For example, as of May 2025, 23% of the S&P 500’s total return over the past ten years can be attributed to reinvested dividends. Going further back, from 1960 through 2024, reinvested dividends and compounding accounted for about 85% of the cumulative total return of the S&P 500.
This is why it’s important to take the dividends of a stock into account when selecting an underlying security for your option trade. You can also reinvest your dividends later on if more capital is needed.
Mistake #4: Trading Without a Loss Management Plan
Too many investors enter trades without a clear plan for managing risk
While no one wants a trade to go bad, you should still be prepared for a loss and to manage risk. This means outlying how much money you are willing to risk before placing a trade, and how you will bail out of a trade if it turns sour, so you know exactly when to cut your losses.
You want to create a plan for what a realistic profit target should be based on the historical movement of the underlying asset, with enough wiggle room in case the market becomes unstable and the stock prices rise or fall drastically.
Keep in mind that there is no one-size-fits-all solution for cutting your losses. Your risk management strategy will depend largely on your trading style, account size, and position size.
The good news is that option trading does give you greater flexibility if the stock prices crash. You always have the option to buy back the call and remove the obligation to deliver the stock, for instance.
Just remember that if the trade starts moving against you, your first instinct shouldn’t be to throw money at it to get it back even. You want to stick to your strategy as much as possible (even if it’s an exit strategy), accepting some loss if necessary. Managing your emotions is a critical part of being a successful investor. To learn more, take our free course.
Not every trade will be profitable, but you can minimize risk by having a solid strategy before you begin investing.
Mistake #5: Expecting Immediate Returns
Finally, option traders should be prepared to invest for the long haul and not expect immediate returns. While option trading can be profitable, nothing is guaranteed and it is in no way, shape or form a “get rich quick” strategy.
It will still take some time to see the returns you want. A realistic goal would be to aim for around 10-12% return on your investments per year.
Again, it’s important to have a plan in case those returns are lower than expected, but for the most part, your strategy should be for consistent returns over several years, not months.
Final Thoughts
Selling covered calls can be a great way to generate income, if you know how to avoid the most common mistakes made by new investors.
This includes:
- Choosing the right strike price and expiration
- Making sure your calls are covered (that you own the underlying securities if possible)
- Choosing stocks that also pay dividends
- Having a plan should you incur any loss
- Planning for the long-term and not expecting quick results
By steering clear of these pitfalls, you’ll greatly improve your chances of building a portfolio that generates dependable income year after year.