Covered Calls

Learn how to utilise covered calls and add them to your arsenal

Introduction Articles

What are Options?
1 year(s) ago
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Call Options
1 year(s) ago
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Put Options
1 year(s) ago
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Strike Price
1 year(s) ago
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Options Pricing
1 year(s) ago
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Bid and Ask Price
1 year(s) ago
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Hedging with Options
1 year(s) ago
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Covered Calls
1 year(s) ago
19 minutes Read
Protective Put
1 year(s) ago
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Options Assignment
1 year(s) ago
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What is a Covered Call?

This is a way to boost profits/earn income on a position that you already hold in your portfolio. Generally, investors will hold a stock or share and wait for dividends, but with this strategy you can make these holdings work harder. This option strategy involves you holding a long position in a stock, and then selling call options on that same stock to generate extra income.

Covered calls are profitable within a defined range; profiting if the stock price drops by less than the amount of your sold call option, and remaining profitable if the stock moves up to or beyond the strike price of the call you sold. The maximum gain is realised if the stock price is at the strike price on expiry, the full value of the sold call is retained while the stock has achieved its maximum rise without being assigned.

 

A graph showing a Covered Call, indicating break even, strike price and profit.

Covered Call Example

For example, you hold shares in a stock and believe in the long run this stock will do well. In the short term, your view is that the stock will be pretty flat but you would also consider selling the stock if the right terms were offered. With this in mind, you can sell a call option on this stock to generate extra income over the short term.

Let’s just say that XYZ Plc is trading at 405. If you sell a call option on XYZ Plc at a strike price of 420 at a premium of 15, you earn the premium from the option sale but also cap your upside potential to 420. One of these three things is going to happen with the position:

 

  •  XYZ Plc trades flat and remains below your strike price of 420 – the option will expire worthless and you keep the 15 premium you took in from the option. By doing this, you have successfully outperformed the stock.
  •  XYZ Plc shares fall in price – the option expires worthless, you keep the premium, and again you outperform the shares and can look to sell a covered call again.
  • XYZ Plc rises above 420 – your option is exercised, and your upside is then capped at 420, plus the 15 premium from selling the call option. Although this is still a profitable outcome it will not be as profitable if XYZ Plc trades above 435 (breakeven price) at expiry of the call option.

 

Covered Call Summary

CONFIGURATION:

  • Currently own the underlying asset
  • Sell a call with a strike price near the current market price

OUTLOOK:

  • Neutral.

TARGET:

  • You want the stock to remain as close to the strike price as possible without going above it at expiry

PROS:

  • Can generate extra income from your underlying asset
  • Benefits from time decay and falling volatility

CONS

  • Can restrict the upside potential of your underlying asset
  • Short call can be exercised early if European style option
  • Can be margin intensive if underlying asset rises sharply

 

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