Using the covered call option strategy, the investor gets to earn a premium writing calls while at the same time appreciate all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares.

By selling a covered call against long stock the cost basis is reduced by the premium collected for the short call. The short call that is sold against the stock is usually in the front month (about 45 days to expiration) and one strike out of the money (OTM). This short call should have a probability of expiring ITM of about 30%. This bullish strategy is best used in low priced stocks with high volatility.

In addition to the premium received for writing the call, the OTM covered call strategy's profit also includes a paper gain if the underlying stock price rises, up to the strike price of the call option sold.

Limited (But High) Risk

Potential losses for this strategy can be very large and occurs when the price of the underlying security falls. However, this risk is no different from that which the typical stock owner is exposed to. In fact, the covered call writer's loss is cushioned slightly by the premiums received for writing the calls.

The investor/trader may chose to roll a covered call when the assumption remains the same (that the price of the stock will continue to rise). Rolling the short call should occur when the option has little to no extrinsic value.

Limited Profit

The profit on the covered call strategy is limited to the strike price of the call sold less the net cost basis in the overall position.

To calculate the maxuimum profit:

Premium Received - Purchase Price of Underlying + Strike Price of Short Call - Commissions Paid
Max Profit Achieved When Price of Underlying >= Strike Price of Short Call

Breakeven

The breakeven is determined by taking the Purchase Price of the Underlying and subtracting the net Premium received for the sale of the call.

Risk Graph