(Long) Covered Call

A (long) covered call is an option strategy in which a trader holds (is long) a position on a stock/ETF and subsequently sells (writes, or is short) a call option on the same security in order to earn premiums (as a form of income for many investors).

Options level required to trade this strategy: Level 2

Available in a Registered account? - Yes

Strategy benefits

• Receive income from the option premium when you sell call options.
• Offset (some) losses if your stock depreciates in value.

Strategy downsides

• May lose your stocks (being “called away”) if the stock value rises beyond the strike price of the option, and the contract is exercised.
• Even if your stock rises in share price significantly, your gains are capped by the strike price (plus the option premium received).
• If the stock drops in price significantly, the option premium you receive will not be enough to offset your losses in share price.

Setting up the strategy

1. Buy (or already own) at least 100 shares of an underlying stock or ETF.
2. Sell a call option on the same underlying security.

There are 2 main goals traders have with this strategy:

1. Goal: Sell call option on the underlying stock/ETF to produce supplementary income.
   • Ideal result at expiry: Security should be close to the strike price, but not above it.
2. Goal: Sell stock/ETF at expiry, while earning additional profit from selling the call option.
   • Ideal result at expiry: Security should be slightly above the strike price, so the call option is assigned.

Covered call example

You own 100 shares of ABC stock valued at $45. In the short term (less than 30 days) you expect the stock price to rise slightly to a maximum value of $48.

You sell a $50 strike call option on ABC stock that expires in 30 days, which earns you an option premium valued at $100 ($1 x 100 shares = $100).

Note: One option contract = 100 shares.

This means that the buyer of the call option has the right to purchase the stock at a $50 strike price prior to the 30-day expiration date.

Possible results:

1. ABC shares go up slightly for the next 30 days, rising to $47.50, but still well below the strike price of $50. The 50 call option expires worthless, and you keep the call option premium ($100), plus you earn an additional $250 because the shares went up $2.50. Your total profit would be $350.
2. ABC shares drop to $44, meaning the call option expires worthless, and you keep the call option premium ($100). However you lose $1 per share ($1 x 100 = $100) because the share price dropped from $45 to $44. Since the option premium offsets the share depreciation, you break even.
3. ABC shares rise to $52, slightly above the $50 strike price, meaning the call option is exercised by the buyer. Although your profit upside was capped at $50, you miss out on an additional profit of $200 ($2 x 100). Still, this gives you a total profit of $600.
4. ABC shares drop to $40, well below the strike price, meaning the call option expires worthless. Although you keep the option premium ($100), you incur significant loss by owning the shares themselves ($5 x 100 = $500). Your total loss would be $100 (call option premium) – $500 (share depreciation) = -$400. 

Profit and loss explained

Maximum profit

Maximum profit = [(strike price – stock purchase price) x number of shares] + (option premium x number of option contracts x number of shares per contract)

Maximum loss

Maximum loss = (stock purchase price x number of shares) – (option premium x number of option contracts x number of shares)

Although you receive a premium when you sell a call option, most of the risk comes from owning the underlying asset(s) themselves because the stock/ETF may actually drop in value before the option’s expiry date.

Break-even at expiration

Break-even point = stock/ETF purchase price – option premium received per share.