Covered Call¶
OVERVIEW¶
A covered call is a two-legged position combining 100 shares of stock with a short call option written against those shares. The option buyer pays a premium upfront; in exchange, you agree to sell your shares at the strike price if the stock closes above it at expiration. The strategy converts a pure equity position into a yield-generating one at the cost of forfeiting gains above the strike.
Note
The downside risk of a covered call is identical to owning the stock outright. The premium collected cushions losses but does not eliminate them.
PAYOFF STRUCTURE¶
Three values define every covered call position.
| Metric | Formula |
|---|---|
| Max Profit | (Strike − Purchase Price) + Premium Collected |
| Breakeven | Purchase Price − Premium Collected |
| Max Loss | Purchase Price − Premium Collected (stock to zero) |
Above the strike at expiration, shares are called away and all upside beyond that point is forfeited.
WORKED EXAMPLE¶
Underlying: AAPL Position: 100 shares purchased at $195.00 Short Call: $200 strike, 30 days to expiration, $3.20 premium ($320 total)
| Scenario at Expiration | P&L |
|---|---|
| AAPL at $180 (−7.7%) | −$1,180 (−$1,500 stock loss + $320 premium) |
| AAPL at $191.80 (breakeven) | $0 |
| AAPL at $195 (flat) | +$320 (premium only) |
| AAPL at $200 (at strike) | +$820 (max profit) |
| AAPL at $215 (surge) | +$820 (capped — $1,500 upside forfeited) |
Tip
The $3.20 premium represents a 1.6% yield on the $195 position over 30 days. Repeated monthly, this annualizes to approximately 20%.
COMMON USE CASES¶
| Use Case | Description |
|---|---|
| Income on a hold | Sell monthly calls on a core position to generate yield while a longer-term thesis develops |
| Cost basis reduction | Repeatedly collect premium to lower the effective purchase price of shares over time |
| Managed exit | Sell a call at your target exit price — either collect premium or get filled at the desired price |
LIMITATIONS AND RISKS¶
Note
A covered call does not protect against large drawdowns. A 30% drop in the stock is a 30% loss offset only by the small premium buffer.
Key risks to understand before using covered calls in Tapeboard:
- Capped upside — selling the call surrenders all gains above the strike price
- Tax consequences — if shares are called away, the holding period may reset from long-term to short-term depending on strike and timing, triggering an unexpected tax event
- Earnings risk — selling calls before earnings to harvest elevated implied volatility carries the highest assignment and gap risk; a post-earnings rally can blow through the strike dramatically
- No free income — the premium received reflects the real value of the right being sold