Covered Call
Overview:
The covered call strategy is one of the most popular options. It is especially popular among investors taking their first crack at options trading. The strategy is typically employed when the underlying stock is already owned by the investor. The owner then sells a call option based off 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, and can deliver the shares if needed, without an additional cash outlay.
Main Uses:
There are two main reasons why an investor would want to sell calls against shares of stock that they own:
- The first reason an investor will use this strategy is to generate additional income on the underlying. When the investor looks to generate additional income, 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 shares of the underlying stock.
- The second reason an investor will use this strategy is to ‘lock-in’ some of their gains. If the investor has owned the stock for some time and made a tidy profit, she may be willing to sell an option that has a higher probability of being exercised. This offers some protection 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 position on Las Vegas Sands (LVS) using the OptionsHouse P&L calculator in a
virtual trading account. The current stock price was $24.70. In this trade, an out-of-the-money call option with a strike price of $25 was sold for $4.60. The breakeven point is the premium received subtracted from the price paid for the stock.
In this example, the maximum potential gain is achieved if the stock price is above $25 at expiration. The maximum gain is capped at the premium collected for selling the call ($4.60) plus any upside between the stock price and the strike price (in this example, $25 minus $24.70). Because of the long stock position, the potential loss is theoretically unlimited down to the zero mark (but will be offset by the premium collected for selling the call).
Educational Content Related to Covered Calls
For a quick view of the most popular options trading strategies on one page, check out our Options Strategies Quick Reference Guide
