Covered Call Basics
A covered call is an options strategy geared towards earning income while holding the underlying stock. To place this trade, you would need to hold a long position of at least 100 shares then sell a call option against that same position to generate income. The strategy will limit potential profits if the stock has a significant move up but adds no additional risk and reduced the cost basis of the share position.
SETUP
Buy 100 Shares of the Stock
Sell an OTM Call Option
PROFIT AND LOSS
The ideal situation for this trade would be the stock price increasing to the short call strike price, but no further. This would allow the max possible gain on the underlying stock while also collecting the full premium from the option. You could then decide to either continue holding the stock or decide to sell another call against those shares. The maximum risk on this trade is similar to just holding the underlying stock. As the stock you hold goes down in value, you will continue to lose money. However, unlike with a stock position only, selling the covered call against those shares reduces the overall cost basis. This risk to the downside is reduced by the premium collected.
LEVEL OF RISK
A covered call is a low-risk strategy and a good starting point for those new to options. It allows you to generate income off your share position, while also reducing your risk to the downside. The main disadvantage for this trade being the limit to potential upside if the stock were to increase dramatically. You would not want to implement a covered call strategy if you thought the stock was going to have a significant rise in the near the future.
MAX PROFIT
Difference Between the Stock Purchase Price and Short Call Strike Price + Credit Received
BREAKEVEN
Stock Purchase Price – Credit Received
