Covered Call
Sell call against owned shares
What is Covered Call?
Covered Call A covered call is an income-generating options strategy where the trader owns 100 shares of an underlying stock and sells (writes) a call option against those shares. The strategy collects premium upfront and profits if the stock stays below the short call strike at expiration. The shares serve as collateral against potential assignment, hence "covered." Mechanics: - Own 100 shares of the underlying - Sell 1 call option (typically OTM, 25-30 delta) - Collect premium upfront - If stock stays below strike: keep premium + retain shares - If stock closes above strike: shares are called away at strike (premium kept + capital gain to strike) Worked example: AAPL at $185 with 100 shares - Sell 1 AAPL $190C 30 DTE at $2.20 - Premium received: $220 - If AAPL closes below $190: keep $220 premium + shares. Repeat next month. - If AAPL closes above $190: shares called away at $190. Total profit: $220 premium + $500 capital gain = $720 per contract. Upside above $190 is forfeited. Covered calls are popular for income-focused investors who: - Already own dividend stocks or core equity positions - Want supplemental income (~5-10% annualized on top of dividends and capital gains) - Accept capping upside on individual rallies in exchange for steady premium - Have a long-term hold thesis on the underlying Strike selection trade-offs: - **25-30 delta** (typical default): ~30% assignment probability, moderate premium. Best balance for most accounts. - **15-20 delta** (further OTM): lower premium, lower assignment risk. Good for stocks you don't want called away. - **40+ delta** (closer to ATM): higher premium, higher assignment risk. Used when willing to part with shares at the strike. Common covered call mistakes: - **Selling on stocks you don't want to part with** at the strike - **Going too close to ATM for higher premium** — assignment risk soars - **Letting deep ITM calls drift into assignment** without rolling - **Disqualifying long-term capital gains** by selling unqualified deep-ITM CCs (tax issue) Covered calls are mathematically equivalent to cash-secured puts at the same strike — both have the same payoff diagram. The difference is starting position: covered call begins with shares; CSP begins with cash. Many income traders rotate between the two as part of the wheel strategy. Covered call backtest patterns (illustrative): over multi-year periods on liquid ETFs like SPY, covered calls produce 4-8% annualized premium income on top of stock returns, with materially lower drawdown but capped upside on bull rallies. The strategy outperforms buy-and-hold in flat or down markets and underperforms in strong rallies.
Complete Definition
A covered call is an income-generating options strategy where the trader owns 100 shares of an underlying stock and sells (writes) a call option against those shares. The strategy collects premium upfront and profits if the stock stays below the short call strike at expiration. The shares serve as collateral against potential assignment, hence "covered." Mechanics: - Own 100 shares of the underlying - Sell 1 call option (typically OTM, 25-30 delta) - Collect premium upfront - If stock stays below strike: keep premium + retain shares - If stock closes above strike: shares are called away at strike (premium kept + capital gain to strike) Worked example: AAPL at $185 with 100 shares - Sell 1 AAPL $190C 30 DTE at $2.20 - Premium received: $220 - If AAPL closes below $190: keep $220 premium + shares. Repeat next month. - If AAPL closes above $190: shares called away at $190. Total profit: $220 premium + $500 capital gain = $720 per contract. Upside above $190 is forfeited. Covered calls are popular for income-focused investors who: - Already own dividend stocks or core equity positions - Want supplemental income (~5-10% annualized on top of dividends and capital gains) - Accept capping upside on individual rallies in exchange for steady premium - Have a long-term hold thesis on the underlying Strike selection trade-offs: - **25-30 delta** (typical default): ~30% assignment probability, moderate premium. Best balance for most accounts. - **15-20 delta** (further OTM): lower premium, lower assignment risk. Good for stocks you don't want called away. - **40+ delta** (closer to ATM): higher premium, higher assignment risk. Used when willing to part with shares at the strike. Common covered call mistakes: - **Selling on stocks you don't want to part with** at the strike - **Going too close to ATM for higher premium** — assignment risk soars - **Letting deep ITM calls drift into assignment** without rolling - **Disqualifying long-term capital gains** by selling unqualified deep-ITM CCs (tax issue) Covered calls are mathematically equivalent to cash-secured puts at the same strike — both have the same payoff diagram. The difference is starting position: covered call begins with shares; CSP begins with cash. Many income traders rotate between the two as part of the wheel strategy. Covered call backtest patterns (illustrative): over multi-year periods on liquid ETFs like SPY, covered calls produce 4-8% annualized premium income on top of stock returns, with materially lower drawdown but capped upside on bull rallies. The strategy outperforms buy-and-hold in flat or down markets and underperforms in strong rallies.
Example
100 shares of MSFT at $415. Sell 1 MSFT $425C 30 DTE for $4.50 credit ($450). One month later, MSFT closes at $420. Call expires worthless. Trader keeps $450 premium + retains shares. Annualized premium yield: ~13% on the shares. Rinse, repeat monthly.
Related Terms
Frequently Asked Questions
What is a covered call?
A covered call is selling a call option against 100 shares of underlying stock you already own. The shares cover the call's potential assignment. The strategy collects premium upfront and profits if the stock stays below the short call strike. Common income-generating strategy for long-term equity holders.
What's the maximum profit on a covered call?
Premium received + capital gain from current price to strike (if assigned). If the stock stays below the strike at expiration, the trader keeps the premium and retains the shares. If assigned, shares are sold at the strike and any further upside is forfeited.
Are covered calls risky?
Less risky than naked calls (which have unlimited risk). The shares serve as protection if the stock rises — you simply sell them at the strike. The risk is the underlying falling, which would still affect your shares regardless of the covered call. Total position is equivalent to long stock with capped upside.
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