A covered call is where you hold a long position in your underlying stock and sell a call option on that same stock, receiving the premium as income.
Description
The potential profit from a covered call strategy is the premium received plus any increase in the stock price, while the maximum loss is limited to the price paid for the stock minus the premium received. If the stock price rises above the strike price before the option expires, the investor will not be able to realize the full increase in the stock price, as they will be required to sell the stock at the strike price. However, you will still keep the premium received as profit.
If the stock price does not rise above the strike price before the option expires, the investor will not be required to sell the stock and will keep both the stock and the premium received as profit. However, if the stock price declines significantly, the investor will incur a loss equal to the difference between the price paid for the stock and the current market price.
A covered call strategy can be a good choice for investors who are looking to generate income from their stock holdings while also limiting their potential losses. However, it’s important to carefully consider the potential risks and rewards before implementing this strategy.
Breakeven
Current stock price minus the premium received for selling the call.
Sweet Spot
Depends on your objectives:
- Selling covered calls to earn income on your sock, then you want the stock to remain as close to the strike price as possible without going above it
- Sell the stock while making additional profit by selling the calls, then you want the stock to rise above Leg 2 (Strike price), so calls will be assigned.
Max Profit
Is the premium received plus any increase in the stock price. This is the profit that an investor will realize if they are able to sell the stock at a higher price than the breakeven point
Max Loss
Is limited to the price paid for the stock minus the premium received. This is the loss that an investor will incur if the stock price declines significantly and they are not able to sell the stock at a higher price than the price paid.
