Covered Call Strategy
A covered call is an options trading strategy that involves holding a long position in a stock while simultaneously selling (writing) a call option on the same stock. This strategy is popular among investors looking to generate additional income from stocks they already own.
How to Set It Up
- Buy (or already own) 100 shares of a stock.
- Sell 1 call option contract against those shares (1 contract = 100 shares).
- Choose a strike price above the current market price and an expiration date.
Benefits
- Earn premium income from the call option.
- Provides limited downside protection.
- Works well in sideways or slightly bullish markets.
Risks
- If the stock rises above the strike price, you may be forced to sell at that price and miss out on further gains.
- Limited upside potential.
- If the stock drops significantly, the option premium may not cover the loss.
Example: Covered Call on Tesla
Imagine you own 100 shares of Tesla bought at $300. You sell a call option with a $320 strike price and receive a $10 premium per share. Here's how your profit/loss changes based on Tesla's price at expiration:
| Tesla Price | Stock P/L | Option P/L | Total P/L |
|---|---|---|---|
| $270 | −$3,000 | +$1,000 | −$2,000 |
| $300 | $0 | +$1,000 | +$1,000 |
| $310 | +$1,000 | +$1,000 | +$2,000 |
| $320 | +$2,000 | +$1,000 | +$3,000 |
| $340+ | +$2,000 | +$1,000 | +$3,000 |
As the table shows, your maximum profit is capped at $3,000 (strike gain + premium), and your losses are reduced by the premium you received. This is the core trade-off of a covered call.
Custom payoff diagram of a Covered Call strategy using Tesla as an example