What is a Covered Call?
A Covered Call strategy involves holding a long position in a stock (owning the stock) and selling a call option on the same stock. This strategy generates income through the option's premium while limiting upside potential.
One Call Option Contract typically covers 100 shares. In this example, we assume:
- You own 100 shares of stock.
- You sell one call option contract (which covers 100 shares).
- You receive a premium of $3 per share for selling the call option.
How Payoff and Value Work:
Let’s say the initial stock price is $100 and the strike price of the call option is $105:
- If the stock price stays below $105, the option is not exercised, and you keep the premium plus the value of the stock.
- If the stock price rises above $105, the option buyer will exercise the option, forcing you to sell your shares at $105, even if the stock price rises further.
Example Payoff and Total Value Scenarios:
- Stock Price = $90:
Payoff = Stock Value ($9,000) + Premium ($300) - Initial Cost ($10,000) = Payoff = -$700
Total Portfolio Value = $9,000 (stock) + $300 (premium) = $9,300.
- Stock Price = $100:
Payoff = Stock Value ($10,000) + Premium ($300) - Initial Cost ($10,000) = Payoff = $300
Total Portfolio Value = $10,000 (stock) + $300 (premium) = $10,300.
- Stock Price = $110:
Payoff = Strike Price ($105) + Premium ($300) - Initial Cost ($10,000) = Payoff = $800
Total Portfolio Value = $10,500 (from selling at $105) + $300 (premium) = $10,800.