The analysis is the same, except that the investor must adjust the results for any prior unrealized stock profits or losses. The maximum loss is limited but substantial. The worst that can happen is for the stock to become worthless. In that case, the investor will have lost the entire value of the stock.
However, that loss will be reduced somewhat by the premium income from selling the call option. It is also worth noting that the risk of losing the stock's entire value is inherent in any form of stock ownership. In fact, the premium received leaves the covered call writer slightly better off than other stock owners. The total net gains depend in part on the call's intrinsic value when sold and on prior unrealized stock gains or losses.
The maximum gains at expiration are limited by the strike price. If the stock is at the strike price, the covered call strategy itself reaches its peak profitability, and would not do better no matter how much higher the stock price might be. The strategy's net profit would be the premium received, plus any stock gains or minus stock losses as measured against the strike price. That maximum is very desirable to investors who were happy to liquidate at the strike price, whereas it could seem suboptimal to investors who were assigned but would rather still be holding the stock and participating in future gains.
The prime motive determines whether the investor would consider post-assignment stock gains as irrelevant or as a lost economic opportunity. This strategy may be best viewed as one of two things: a partial stock hedge that does not require additional up-front payments, or a good exit strategy for a particular stock.
An investor whose main interest is substantial profit potential might not find covered calls very useful. The potential profit is limited during the life of the option, because the call caps the stock's upside potential. The main benefit is the effect of the premium income. It lowers the stock's break even cost on the downside and boosts gains on the upside. The best-case scenario depends in part on the investor's motives.
First, consider the investor who prefers to keep the stock. If at expiration the stock is exactly at the strike price, then the stock theoretically will have reached the highest value it can without triggering call assignment. The strategy nets the maximum gains and leaves the investor free to participate in the stock's future growth.
By comparison, the covered call writer who is glad to liquidate the stock at the strike price does best if the call is assigned -- the earlier, the better. Special Considerations. Example of a Covered Call. Are Covered Calls Profitable? Are Covered Calls Risky? Is There a Covered Put? Key Takeaways A covered call is a popular options strategy used to generate income in the form of options premiums. Investors only expect a minor increase or decrease in the underlying stock price for the life of the option when they execute a covered call.
To execute a covered call, an investor holding a long position in an asset then writes sells call options on that same asset. Covered calls are often employed by those who intend to hold the underlying stock for a long time but do not expect an appreciable price increase in the near term. This strategy is ideal for investors who believe the underlying price will not move much over the near term. Are Covered Calls a Profitable Strategy? Article Sources.
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We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Ratio Call Write Definition A ratio call write is an options strategy where more call options are written than the amount of underlying shares owned.
Options Contract Definition An options contract gives the holder the right to buy or sell an underlying security at a predetermined price, known as the strike price. How the Variable Ratio Write Option Strategy Works A variable ratio write is an options strategy that requires holding shares of the underlying asset while writing call options at varying strike prices.
Buy-Write Definition Buy-write is an options trading strategy where an investor buys an asset and simultaneously writes sells a call option on that asset. What Is a Fiduciary Call? When to Sell a Covered Call. Advantages of Covered Calls. Risks of Covered Calls. The Bottom Line. Key Takeaways A covered call is a popular options strategy used to generate income from investors who think stock prices are unlikely to rise much further in the near-term.
A covered call is constructed by holding a long position in a stock and then selling writing call options on that same asset, representing the same size as the underlying long position.
A covered call will limit the investor's potential upside profit, and will also not offer much protection if the price of the stock drops. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Related Articles. Partner Links. Related Terms Ratio Call Write Definition A ratio call write is an options strategy where more call options are written than the amount of underlying shares owned. Options Contract Definition An options contract gives the holder the right to buy or sell an underlying security at a predetermined price, known as the strike price. Non-Equity Option Definition A non-equity option is a derivative contract with an underlying asset of instruments other than equities.
What Is an Outright Option? Consider days in the future as a starting point, but use your judgment. You want to look for a date that provides an acceptable premium for selling the call option at your chosen strike price. Remember, with options, time is money. The further you go out in time, the more an option will be worth. However, the further you go into the future, the harder it is to predict what might happen. On the other hand, beware of receiving too much time value. Check for news in the marketplace that may affect the price of the stock, and remember if something seems too good to be true, it usually is.
A Guide to Covered Call Writing. Obviously, the bad news is that the value of the stock is down. The risk comes from owning the stock.
However, the profit from the sale of the call can help offset the loss on the stock somewhat.
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