Covered Call Explained
A covered call is long stock plus a short call against it: you collect premium and cap your upside in exchange for a small cushion on the downside.
What it is
A covered call is the most common income strategy in equities: you own 100 shares and sell one out-of-the-money call against them. The premium is yours to keep. In return you agree to sell your shares at the strike if the stock rallies through it, which caps your upside. The position profits from time decay and from a stock that stays flat or drifts up modestly, and it cushions a small decline by the premium collected. By put-call parity it has the same payoff as a short put at the same strike, so it is structurally a short-volatility, income trade on a name you are happy to own.
Payoff at expiration
When to use it
Reach for a covered call on a holding you are neutral-to-mildly-bullish on and are willing to sell at a higher price. It works best when implied volatility is elevated, so the premium is rich, and when you do not expect a sharp rally that you would regret capping. Overwriters run it monthly on core positions to manufacture yield, choosing a strike that balances premium against how much upside they are willing to give up. Avoid writing calls into a name you expect to gap higher on a catalyst, and be mindful of writing through earnings unless you specifically want to sell that volatility.
Greeks profile
| Delta | Positive but less than owning the stock outright, since the short call gives back upside delta as the stock rises. |
| Gamma | Short gamma from the written call: your effective delta falls as the stock rallies toward the strike. |
| Theta | Positive. The written call decays in your favour every day the stock sits still. |
| Vega | Negative. A drop in implied volatility helps the position; a spike in IV raises the cost to buy the call back. |
Max profit, max loss & break-evens
Max profit = (call strike − stock cost) + premium, reached if the stock finishes at or above the strike. Max loss = stock cost − premium (the stock can fall to zero, cushioned only by the premium). Break-even = stock cost − premium collected.
Concrete example
You own 100 shares bought at 100 and sell the one-month 105 call for 2, collecting 200 dollars. If the stock finishes below 105 you keep the shares and the premium, with a break-even at 98. If it rallies to 110 you are assigned and sell at 105, banking 5 points of stock gain plus the 2 premium for a max profit of 7 per share, but you miss the move above 105. The 2 on a 100 stock in one month annualises to roughly 24 percent of premium yield.
Risks & management
The real risk is the same as owning the stock: a deep sell-off, cushioned only by the premium. The second cost is opportunity, a sharp rally past the strike caps your gain and you watch the stock run without you. Manage by choosing strikes you are genuinely willing to sell at, rolling the call up and out if the stock rallies and you want to keep it, and closing the call to lock in decay when most of the premium is gone. Assignment risk rises as the call goes in-the-money near expiry, especially around ex-dividend dates when early exercise becomes rational.
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