In the Money vs. Out of the Money Covered Calls: Which Pays More Monthly Income?

The Short Answer: ITM Pays More Cash, OTM Keeps More Upside

If you want the biggest premium check deposited into your account right now, selling an in-the-money (ITM) covered call will do it. But that extra cash comes with a real trade-off: you cap your stock gains lower and face a higher chance of having your shares called away. Out-of-the-money (OTM) calls pay a smaller premium but let the stock run further before you lose upside. Neither is universally better — the right choice depends on what you actually want from the trade.

This article walks through exactly how the numbers work, where each approach wins, and what risks you need to understand before you sell a single contract.

What ITM and OTM Actually Mean in Plain English

A call option is in the money when its strike price is below the current stock price. It is out of the money when the strike is above the current stock price.

Example: Apple (AAPL) is trading at $195. A $190 strike call is ITM by $5. A $200 strike call is OTM by $5. A $195 strike call is exactly at the money (ATM).

Every option premium has two parts. Intrinsic value is the amount the option is already in the money — real, immediate value. Extrinsic value (also called time value) is everything else: time left until expiration, implied volatility, interest rates. OTM options have zero intrinsic value. Every dollar of their premium is extrinsic. ITM options carry both intrinsic and extrinsic value, which is why their total premium looks bigger on paper.

Side-by-Side Worked Example Using AAPL

Let's make this concrete. Assume AAPL is trading at $195 and you own 100 shares. You are looking at options expiring in 30 days.

**Scenario A — Sell the $190 ITM Call (delta ~0.65)** Premium collected: $8.20 per share, or $820 for one contract. Breakeven on the downside: $195 − $8.20 = $186.80. Your shares must fall below $186.80 before you lose money on the combined position. Maximum gain: The stock gets called away at $190. You collect $190 + $8.20 = $198.20 total per share. That is a $3.20 gain above today's price, or about 1.6% in 30 days. Probability of assignment (approximate): 65% based on delta as a rough guide per the Options Industry Council (OIC).

**Scenario B — Sell the $200 OTM Call (delta ~0.30)** Premium collected: $2.85 per share, or $285 for one contract. Breakeven on the downside: $195 − $2.85 = $192.15. Maximum gain: Stock gets called away at $200. You collect $200 + $2.85 = $202.85 per share. That is a $7.85 gain above today's price, or about 4.0% in 30 days if the stock reaches $200. Probability of assignment (approximate): 30%.

**Scenario C — Sell the $195 ATM Call (delta ~0.50)** Premium collected: $4.90 per share, or $490 for one contract. Breakeven: $190.10. Maximum gain: $199.90 per share, or about 2.5% in 30 days.

The ITM call deposits nearly three times the cash the OTM call does. But if AAPL climbs to $205, the OTM seller participates in $5 of that move before the cap kicks in. The ITM seller is already capped and misses all of it.

When Does Each Strategy Actually Win?

**ITM covered calls work best when:** — You expect the stock to trade flat or drift slightly lower. — You want maximum downside cushion from the premium. — You are comfortable giving up the shares and are not counting on a big price jump. — You want to reduce your effective cost basis aggressively over several months.

**OTM covered calls work best when:** — You are bullish on the stock and want to keep most of the upside. — The stock has high implied volatility, so even OTM premiums are fat. — You want to generate income without triggering assignment every month. — You plan to hold the stock long-term and do not want to keep repurchasing shares after assignment.

**ATM calls are the middle ground.** Many income-focused traders default here because the extrinsic value — the part that decays fastest — is highest at the money. The CBOE notes that theta decay accelerates in the final 30 days of an option's life, which is why 30-to-45-day expirations are popular for covered-call income strategies.

The Risks You Need to Understand Before You Choose

Selling covered calls is not risk-free. Here is what can go wrong with each approach, stated plainly.

**ITM risk — you lose stock upside fast.** If AAPL jumps from $195 to $215 after you sold the $190 call for $8.20, your shares get called away at $190. You collected $198.20 total. The person who bought your call made $16.80 per share in profit. You left $16.80 on the table. Over a strong bull market, repeated ITM selling can significantly underperform simply holding the stock.

**OTM risk — the premium is thin protection.** If AAPL drops from $195 to $170, your $2.85 OTM premium barely softens the blow. You still own shares worth $170 and your net loss is $22.15 per share. The ITM seller collected $8.20 and has a net loss of $16.80 — meaningfully less damage.

**Assignment risk applies to both.** Any ITM option can be assigned early, especially the day before an ex-dividend date. FINRA and the OIC both flag early assignment as a risk retail traders underestimate. If you are assigned early, you lose the remaining time value you were counting on.

**Liquidity matters.** Deep ITM options sometimes have wide bid-ask spreads. Always check the open interest and volume before selling. Illiquid strikes can cost you 10-20 cents per share just in the spread, which eats into your income.

**Volatility crush.** If you sell an OTM call right before an earnings report expecting a big premium, and the stock barely moves, implied volatility collapses after the announcement. Your option loses value quickly — which is good if you want to buy it back early, but it also means the premium you collected was partly compensation for a risk that did not materialize.

Tax Implications: What the IRS and CRA Say About Covered Calls

Tax treatment is one of the most overlooked parts of the ITM-vs-OTM decision, and getting it wrong is expensive.

**United States (IRS rules):** The IRS treats covered-call premiums as short-term capital gains in the year the position closes, regardless of how long you held the stock — unless the call qualifies as a "qualified covered call." A qualified covered call must not be deep in the money, and the stock must have been held for more than 30 days before the call was written. Deep ITM calls can suspend your holding period on the underlying stock, potentially converting what would have been a long-term capital gain into a short-term gain taxed at ordinary income rates. IRS Publication 550 covers this in detail. If long-term capital gains treatment on your stock matters to you, selling very deep ITM calls can accidentally cost you that benefit.

**Canada (CRA rules):** The Canada Revenue Agency treats option premiums received as capital gains or income depending on whether you are considered a trader or an investor. For most buy-and-hold investors selling covered calls on stocks they own, the CRA generally treats the premium as a capital gain when the option expires worthless or is bought back. If the option is exercised and shares are called away, the premium is added to the proceeds of disposition. Canadian investors should review CRA Interpretation Bulletin IT-479R and consult a tax professional for their specific situation.

The bottom line: before you start selling deep ITM calls to maximize monthly cash, run the numbers on your tax situation. The extra premium may cost you more in taxes than it earns you in income.

A Simple Framework for Choosing Your Strike Each Month

You do not need to pick one strategy and stick with it forever. Most experienced covered-call traders adjust their strike selection based on three questions asked at the start of each expiration cycle.

**1. What is my outlook for the stock this month?** Bearish or flat → lean ITM for maximum premium and cushion. Neutral → ATM for peak time-value decay. Mildly bullish → OTM to keep some upside.

**2. What is implied volatility doing?** Check the stock's IV rank or IV percentile. When IV is high relative to its historical range, OTM premiums are fatter than usual. You can sell further OTM and still collect meaningful income. When IV is low, you may need to move closer to ATM or slightly ITM to get a premium worth the effort. The CBOE publishes volatility data and educational resources on reading IV for exactly this purpose.

**3. Do I actually want to keep these shares?** If you love the stock and want to hold it for years, be careful with ITM calls. Assignment is likely, and you will have to repurchase shares — possibly at a higher price — to keep running the strategy. If you are indifferent to owning the shares and just want income, ITM assignment is not a problem.

A practical starting point for many income-focused traders: sell the 30-delta OTM call in a normal market. That is roughly one standard deviation OTM, gives you a reasonable premium, and leaves room for the stock to breathe. Adjust toward ITM when you want more protection or more cash, and toward further OTM when you are bullish and IV is elevated.

Does selling in the money covered calls always pay more premium than out of the money?

ITM calls always have a higher total premium because they include intrinsic value on top of time value. However, the extrinsic value — the part that decays in your favor — is actually highest at the money, not deep in the money. Deep ITM calls can have very little time value left, meaning most of what you collect is just the intrinsic value you are giving away by capping the stock at a lower price.

What happens if my covered call goes in the money before expiration?

Your call moving in the money does not mean automatic assignment — most options are not exercised early. According to the Options Industry Council (OIC), early assignment is most likely the day before an ex-dividend date when the option is deep in the money. You can always buy the call back before expiration to close the position and avoid assignment if you want to keep your shares.

Can I lose money selling covered calls?

Yes. The premium you collect reduces your cost basis but does not fully protect you from a large drop in the stock price. If AAPL falls $30 and you collected $3 in premium, you still have a $27-per-share loss on the position. Covered calls limit upside more than they limit downside, which is why FINRA classifies them as a moderately conservative strategy rather than a hedging strategy.

How does selling deep ITM covered calls affect my taxes in the US?

The IRS can suspend the holding period on your underlying stock when you sell a deep in-the-money covered call that does not qualify as a "qualified covered call" under IRS Publication 550 rules. This can turn a long-term capital gain on your stock into a short-term gain taxed at ordinary income rates. Always check with a tax professional before selling deep ITM calls on shares you have held for less than a year or are approaching the one-year mark.

What delta should I use when selling covered calls for income?

A delta of 0.30 to 0.40 — roughly one strike OTM — is a common starting point for income-focused covered-call sellers because it balances premium size against the probability of assignment. Higher delta (closer to 0.50 or above) means more premium but higher assignment risk. The CBOE notes that delta approximates the probability that the option will expire in the money, so a 0.30-delta call has roughly a 30% chance of being assigned at expiration.

Should I sell covered calls every month or wait for high volatility?

Selling consistently every month captures the long-run statistical edge of being a premium seller, but timing your sales around elevated implied volatility improves your results. When a stock's IV rank is above 50 — meaning current implied volatility is in the upper half of its one-year range — premiums are above average and you can sell further OTM while still collecting meaningful income. The CBOE publishes IV data that can help you identify these windows.