PREMIUMCovered Call
Overview:
The covered call strategy is one of the most popular options strategies of all time. The strategy is employed when the underlying stock is owned by the investor. The owner then sells a call option based of the underlying stock. The seller of a covered call gains from the premium received and is protected in case the option is called away because she already owns the underlying stock.
Main Uses:
There are two main reasons why an investor would want to sell a call option on the underlying:
- The first reason an investor will use this strategy is to generate additional profit on the underlying. When the investor looks to generate additional profits, usually she will sell an out-of-the-money call option with the hope the option doesn’t become in-the-money and the option will expire worthless. This allows her to keep the premium and the underlying stock.
- The second reason an investor will use this strategy is to ‘lock-in’ profits. If the investor has owned the stock for some time and made a tidy profit, she may be willing to sell an option which has a higher probability of being exercised. This protects her from losing money if the stock decreases in value.
Profit / Loss of Covered Call:
The below graph is a profit / loss graph of a covered call SPY position using the OptionsHouse P&L calculator. The current stock price is $111.78. An out-of-the-money call option with a strike price of 114 was sold for $0.805. The break-even point is the premium received subtracted from the price paid for the stock. In this example, the most gained will be when the stock price reaches $114.13.
(chart courtesy of Optionshouse.com)
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