The Short Answer: ITM for Protection, OTM for Upside

When you sell an in-the-money (ITM) covered call, you collect more premium but cap your upside below the current stock price. When you sell an out-of-the-money (OTM) covered call, you collect less premium but keep more room for the stock to run before your shares get called away. Your choice comes down to one question: do you want more downside cushion right now, or more participation if the stock keeps climbing?

Both approaches work. Neither is universally better. The right strike depends on your cost basis, your tax situation, how bullish you are, and how much income you need each month.

What ITM, ATM, and OTM Actually Mean

A call option is in-the-money (ITM) when its strike price is below the current stock price. It is at-the-money (ATM) when the strike equals the stock price. It is out-of-the-money (OTM) when the strike is above the current stock price.

Example: AAPL is trading at $195. A $190 call is ITM by $5. A $195 call is ATM. A $200 call is OTM by $5. A $205 call is further OTM.

The deeper ITM you go, the higher the premium you collect — but the more intrinsic value that premium contains. The further OTM you go, the lower the premium — but it is made up almost entirely of time value (theta), which decays in your favor as expiration approaches. The Options Industry Council (OIC) describes this intrinsic-versus-extrinsic split as one of the most important concepts for covered-call writers to understand.

Worked Example: Selling ITM vs OTM on AAPL

Assume you own 100 shares of AAPL at a current price of $195. You are looking at a 30-day expiration cycle. Here are three realistic strike choices:

**ITM — $190 strike call:** Premium collected = $8.20. Intrinsic value = $5.00. Time value = $3.20. If AAPL stays flat or drops, you keep the full $820. Your effective downside break-even is $195 − $8.20 = $186.80. But if AAPL rises above $190 at expiration, your shares are called away at $190 — you miss any rally above that level and you sold at a price below where the stock is today.

**ATM — $195 strike call:** Premium collected = $5.10. All time value. Break-even = $189.90. You participate in no upside above $195, but you collected a solid premium with a meaningful cushion.

**OTM — $200 strike call:** Premium collected = $2.75. All time value. Break-even = $192.25. If AAPL rises to $202 by expiration, your shares are called at $200 and you also keep the $2.75 premium — total effective sale price of $202.75. If AAPL drops to $185, you still own the shares but your loss is partially offset by the $275 premium.

Key takeaway: the ITM strike gave you $820 in income but locked in a sale below today's price. The OTM strike gave you $275 but let you profit on a $5 stock move before assignment kicks in.

When Does Selling ITM Make Sense?

Selling an ITM covered call is a defensive move. You are essentially saying: I want maximum premium income right now, and I am not expecting this stock to move much higher in the next 30 days.

Good scenarios for ITM strikes: - You bought the stock at a much lower price and you are comfortable selling it at the ITM strike, locking in a solid gain. - You are bearish short-term but do not want to sell the shares outright. - You want the largest possible premium to offset a recent drop in the stock. - You are writing calls on a stock with low implied volatility where OTM premiums are thin.

The tradeoff is real: if the stock rips higher, you are capped. You will watch the stock trade at $210 while your shares get called away at $190. That opportunity cost is not a paper loss, but it stings.

When Does Selling OTM Make Sense?

Selling an OTM covered call is the more common choice for long-term investors who still want to hold their shares and participate in moderate upside. You are saying: I want some income, but I also want the stock to have room to run.

Good scenarios for OTM strikes: - You are moderately bullish and expect a small to moderate move up. - You want to keep your shares and avoid assignment. - The stock has high implied volatility, so even OTM premiums are attractive. - You are targeting a specific exit price — the OTM strike becomes your target sale price.

The risk with OTM calls is that the premium is smaller. If the stock drops sharply, the $275 you collected on that $200 AAPL call does not protect you much against a $15 decline. You still own a losing position, just with a slightly smaller loss.

Risks You Need to Know Before Picking a Strike

Assignment risk is real at any strike. If your call goes ITM by even one cent at expiration, you may be assigned and your shares sold. FINRA notes that early assignment — before expiration — can happen on American-style options, especially around ex-dividend dates. If you sell an ITM call on a stock about to pay a dividend, watch out: the buyer may exercise early to capture that dividend, and you lose your shares sooner than planned.

Opportunity cost is the hidden risk of ITM calls. You cap your upside the moment you sell. If NVDA announces a blowout earnings report and jumps 20% overnight, your ITM call means you miss most of that move.

Downside risk is the hidden risk of OTM calls. The premium you collect is smaller, so your break-even is higher. A big drop hurts almost as much as if you had not sold the call at all.

Volatility crush matters too. If implied volatility drops sharply after you sell — say, after an earnings event — the option loses value fast. That is good if you want to buy it back early and close the trade. It is bad if you were counting on high premium and the stock did not move.

Finally, do not ignore delta. An ITM $190 call on a $195 stock might have a delta of 0.70, meaning it moves $0.70 for every $1 the stock moves. An OTM $200 call might have a delta of 0.30. Delta tells you how quickly your short call will go deeper ITM — and how fast assignment pressure builds.

Tax Angle: Qualified Covered Calls and Holding Periods

The IRS has specific rules about what it calls a qualified covered call. Under IRS rules (see IRS Publication 550), if you sell a covered call that is too deep ITM, the IRS may suspend the holding period on your underlying shares. This matters if you are trying to qualify for long-term capital gains treatment on those shares.

Generally, a call is not qualified — and can suspend your holding period — if it has more than 30 days to expiration and is sold at a strike more than one strike below the stock's closing price. The exact thresholds depend on the stock price. If your shares are close to the one-year mark for long-term gains, selling a deep ITM call could accidentally reset that clock.

Canadian investors face similar considerations. The Canada Revenue Agency (CRA) treats covered-call premiums as either capital gains or income depending on your trading frequency and intent. If the CRA classifies you as a trader rather than an investor, premiums are fully taxable as income, not at the capital gains inclusion rate. Speak with a tax professional before selling calls on shares where the tax treatment matters to you.

The OIC recommends that all covered-call writers understand the tax consequences of assignment and premium income before entering any position.

A Simple Framework for Choosing Your Strike

Use this three-question process before every covered-call trade:

1. **Am I okay selling these shares at this strike?** If the answer is no, do not sell that strike. Assignment is always possible.

2. **How much downside protection do I actually need?** If you need $8 of cushion, sell ITM. If $3 is enough, sell OTM. Be honest about your risk tolerance.

3. **What does the premium-to-risk ratio look like?** Divide the premium by the current stock price. A $2.75 premium on a $195 stock is a 1.4% return in 30 days. A $8.20 premium is 4.2%. Decide if that extra income is worth the capped upside and potential tax complications.

Most retail covered-call writers land on slightly OTM strikes — one to two strikes above the current price — because it balances income with flexibility. But in choppy or bearish markets, shifting to ATM or slightly ITM can make sense as a defensive adjustment. There is no single right answer. There is only the answer that fits your position, your cost basis, and your goals.

Is it better to sell ITM or OTM covered calls for monthly income?

ITM covered calls generate more premium per trade, which means more monthly income — but you risk having your shares called away at a price below the current market. OTM calls produce less income but give the stock room to rise before assignment. Most income-focused traders use slightly OTM or ATM strikes to balance both goals.

What happens if my covered call goes ITM before expiration?

If your short call goes ITM, you face a higher probability of assignment, meaning your shares could be sold at the strike price. Early assignment can happen at any time on American-style options, especially before an ex-dividend date. You can avoid assignment by buying back the call before expiration, though that costs you some or all of the premium you collected.

Does selling a deep ITM covered call affect my tax holding period?

Yes, it can. The IRS defines rules around qualified covered calls in IRS Publication 550, and selling a call that is too deep ITM may suspend the holding period on your shares. This could prevent you from qualifying for long-term capital gains rates. Check with a tax professional if your shares are approaching the one-year mark.

What delta should I target when selling covered calls?

A delta between 0.20 and 0.35 is a common target for OTM covered-call sellers — it means roughly a 20-35% probability the option expires ITM. ITM calls typically have deltas above 0.50. Lower delta means less premium but a lower chance of assignment; higher delta means more premium but a higher chance your shares get called away.

Can I sell an OTM covered call and still lose money?

Yes. The premium you collect only partially offsets a drop in the stock price. If you sell a $200 OTM call on a $195 stock and collect $2.75, but the stock falls to $175, you still have an unrealized loss of roughly $17.25 per share. The covered call reduced your loss but did not eliminate it.

How far OTM should I go to avoid getting assigned?

There is no guaranteed way to avoid assignment — any call can be assigned if it goes ITM. Going further OTM reduces the probability of assignment but also reduces your premium income. Many traders target strikes that are 3-7% above the current stock price for a 30-day expiration as a practical balance between income and assignment risk.