Covered Call Definition


In fact, the best-case-scenario for this would be the stock price rising slightly, giving you both a modest gain from stock price appreciation and some premium income from the call. When employed correctly, covered calls and covered puts can help manage risk by potentially increasing profits and reducing losses simultaneously. Covered calls are bullish by nature, while covered puts are bearish. The payoff from selling a covered call is identical to selling a short naked put.


This protects you in case the underlying asset doesn’t increase in value. As you might expect, this describes a contract in which the underlying stock price and the strike price are the same. This is the fee you pay to purchase a call option contract. It’s a per-share amount you pay, similar to an insurance premium.

If the asset rises in value, you’ll need to hand it over to the buyer for the strike price. You’ll lose the gain you would have had if you still owned the asset, minus the premium you received. Before diving into the complexities of what a covered call trade is and how it can be used to generate portfolio income lets first define what an option contract is and what it means to each party involved. There are two main types of options, call options and put options.

Covered Call = Lower Risk

Newcomers often start off their options trading journey by employing this strategy. Pin Risk occurs when a strike price is dangerously close to the stock price on expiration. Unless you want to be assigned, it is always wise to trade out of short options if you’re not 100% certain they will close out of the money. If an investor doesn’t believe a stock they own will rise to a certain point by a certain time, they can sell a call option at this strike price and collect the premium received. Dividend Ex-Date- the first day on which the stock trades without the dividend.

Choosing between strike prices simply involves a trade off between priorities. If the short call is out of the money at expiration, it will expire worthless and no action is required. So expiration day has come again, but under this scenario, AMZN has blown past our strike price of 3400, all the way to $3,600 per share. Delta – Delta measures the amount an option price will change as a result of a $1.00 price change of the underlying security. Since call options rise and falldirectlywith the price of the stock, they are assigned deltas between 0 to -1.

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But don’t use a covered call to try to get extra cash from a stock that looks like it’s going to drop significantly in the near or long term. It’s probably best to sell the stock and move on, or you could try to short sell the stock and profit on its decline. By selling a call option, you may feel disinclined to sell your stock until the option expires, though you could repurchase the call option and then sell the stock.

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In order to produce more income, split share corporations will sometimes employ covered call writing and cash-covered put writing. The worst-case scenario is if XYZ’s shares become worthless. If that happens, Jane will lose her initial investment of $5,000. Covered calls are best for long-term investors who own shares in stable companies. Covered calls let you generate additional income from a portfolio of stocks. A must be filled order is a trade that must be executed due to expiring options or futures contracts.

A call is a contract that gives the option buyer the right to buy an underlying asset at a specified price within a specific time period. A covered call strategy isn’t useful for very bullish or very bearish investors. 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.

Strategy 2: Earn Additional Income from Premiums

Call options give the buyer the right, but not the obligation, to buy shares at a set price. You can use covered calls to decrease thecost basis or to gain income from shares or futures contracts. When you use one, you’re adding a profit generator to stock or contract ownership. The main drawbacks of a covered call strategy are the risk of losing money if the stock plummets and the opportunity cost of having the stock “called” away and forgoing any significant future gains in it. When you sell a covered call, you get paid in exchange for giving up a portion of future upside. For example, assume you buy XYZ stock for $50 per share, believing it will rise to $60 within one year.

  • The more popular the contract is with options traders, the greater the Open Interest.
  • The premium on this call option is $3 per share in the contract.
  • If the stock skyrockets after you sell the shares, you might consider kicking yourself for missing out on any additional gains, but don’t.

However, let’s say the call has not been assigned by expiration. That’s OK. The investor keeps the premium and is free to earn more premium income by writing another covered call, if it still seems reasonable. While the profit from the option is limited to the premium received, it’s possible the investor might be holding a significant unrealized gain on the stock. You could view the strategy as having protected some of those gains against slippage.

What is a covered call?

As a result, we have no reason to believe our customers perform better or worse than traders as a whole. Say you buy 100 shares of $AAPL at $100 per share and the stock runs up to $110. You still would like to hold it for the long term but you think it is going to pullback in the short term. When you sell an option you receive a premium that you will get to keep if the option expires out of the money.


A covered call is a relatively low-risk way to trade options since you protect the short call with your stock position. A covered call can generate income from a stock position that may or may not pay a dividend, increasing its overall profitability. Options trading entails significant risk and is not appropriate for all investors. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.

The Sharpe ratio would be equal to 10 percent minus 4 percent divided by 20 percent, or 0.3. First, choose a stock in your portfolio that has already performed well, and which you are willing to sell if the call option is assigned. Avoid choosing a stock that you’re very bullish on in the long-term. That way you won’t feel too heartbroken if you do have to part with the stock and wind up missing out on further gains. S&P 500 — and then sell calls against that index in an effort to generate additional income. Selling a covered call, on the other hand, means selling a call on a stock you do own.

When to Sell a Covered Call

Avoiding pain and pursuing comfort is the healthy, innate, human response to situations. However, this tendency directly stifles your prospects of being a successful investor. Market AwarenessMarket awareness refers to our ability to assess the entire stock and option marketplace from a macro level. Many or all of the products featured here are from our partners who compensate us.

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Keep in mind, short options can be assigned at any time up to expiration regardless of the ITM amount. A covered call is an options trading strategy that allows an investor to profit from anticipated price rises. To make a covered call, the call writer offers to sell some of their securities at a pre-arranged price sometime in the future.

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Lower loss potential compared to a traditional covered call. Last Trade – the date/time of the last trade for the option. Options information is delayed a minimum of 15 minutes, and is updated at least once every 15-minutes through-out the day. Bid- The highest price that a BUYER is willing to pay, or the price at which you can sell the option. Dividend- the dividend the equity pays on the Ex-Dividend Date. On the morning of the Dividend Ex-Date, the stock’s price is lowered by the amount of the dividend that was just paid.

The naked put profit/loss profile is similar to the covered call profit/loss profile. An out of the money option has no intrinsic value, but only possesses extrinsic or time value. Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA.

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