A covered call would be considered by someone who would like to derive additional income from a long stock position.\u00a0 A covered call allows the investor to hold a long equity position while simultaneously receiving the premium from selling an equal amount of call options against it. The covered call writer is bullish on the stock\u2019s long-term potential but is willing to forego a stock\u2019s upside above the strike during the life of the option in order to receive the proceeds of the call premium.\u00a0 The covered call writer benefits from time decay, from a reduction in volatility and if the stock increases its dividend before expiration.\u00a0 It should be noted that the combined position has a similar profile to that of a short put.\u00a0 The covered call writer remains exposed to any downside in the underlying shares, meaning his loss potential is substantial.<\/p>\n
Market Outlook- Mildly Bullish<\/p>\n
Volatility View- Premium decreases<\/p>\n
Time Erosion- Helps<\/p>\n
Dividends- Premium increases<\/p>\n
Interest Rate- Premium decreases<\/p>\n
Profit Potential- Limited to gains from equity to the strike price, plus premium received from the sale of call option<\/p>\n
Loss Potential- Limited to downside movement in the equity minus the premium received from the sale of call option<\/p>\n
Components Long equity, short call option<\/p>\n
Covered Call Example: <\/strong><\/p>\n Profit potential:<\/strong> Limited to the gain on the underlying share price until the strike price is reached, plus the premium received from the sale of the call option. Thereafter, gains from the stock are equally offset by the rising cost of the short call option.<\/p>\n Potential <\/strong>profit: <\/strong>@$54.00 \u2013 The sum of the gain on the stock ($54.00 – $50.00 = $4.00) plus the premium of $1.75 received from the sale of the call for a total of $5.75.<\/p>\n @$55.00 \u2013 The strike price marks the maximum potential profit from the strategy. The gain on the stock of $5.00 is added to the premium of $1.75 received from the sale of the call. At the strike price, the call has zero extrinsic value at expiration. The investor sold it initially for $1.75, and so retains the entire premium. At any point above the strike price at expiration, what the investor gains from the stock, he loses penny-for-penny on the short call option.<\/p>\n @$44.00 \u2013 At any price below the call strike the option expires worthless and the investor keeps the entire premium. However, the stock has fallen by $6.00 per share. That loss is partially offset by the premium received from the sale of the call option. So the overall loss at $44.00 per share is $6.00 – $1.75 or $4.25.<\/p>\n Maximum loss:<\/strong> Limited by the fact that the stock can only fall to zero. However, the investor starts to lose money at the share purchase price less the premium received ($50.00 minus $1.75 = $48.25) and continues to lose penny-for-penny as the share price declines further.<\/p>\n\n
\n\n
\n Underlying Stock<\/td>\n \u00a0$\u00a0\u00a0 50.00<\/td>\n <\/td>\n Underlying Stock<\/td>\n Call P&L<\/td>\n Stock P&L<\/td>\n Total<\/td>\n<\/tr>\n \n Short Call Strike<\/td>\n \u00a0$\u00a0\u00a0 55.00<\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 10.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(4,000.00)<\/td>\n \u00a0$(3,825.00)<\/td>\n<\/tr>\n \n Premium<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 1.75<\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 20.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(3,000.00)<\/td>\n \u00a0$(2,825.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 25.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(2,500.00)<\/td>\n \u00a0$(2,325.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 30.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(2,000.00)<\/td>\n \u00a0$(1,825.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 35.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(1,500.00)<\/td>\n \u00a0$(1,325.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 40.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$(1,000.00)<\/td>\n \u00a0$\u00a0\u00a0\u00a0 (825.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 45.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0 (500.00)<\/td>\n \u00a0$\u00a0\u00a0\u00a0 (325.00)<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 50.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 –<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 55.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 175.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 500.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 675.00<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 60.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 (325.00)<\/td>\n \u00a0$\u00a0 1,000.00<\/td>\n \u00a0$\u00a0 \u00a0 \u00a0675.00<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 70.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 (1,325.00)<\/td>\n \u00a0$\u00a0 2,000.00<\/td>\n \u00a0$\u00a0 \u00a0 \u00a0675.00<\/td>\n<\/tr>\n \n <\/td>\n <\/td>\n <\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 80.00<\/td>\n \u00a0$\u00a0\u00a0\u00a0\u00a0 (2,325.00)<\/td>\n \u00a0$\u00a0 3,000.00<\/td>\n \u00a0$\u00a0 \u00a0 \u00a0675.00<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n