Optionsstrategie

What Is a Covered Call?

A covered call is an options trading strategy in which an investor holds a long position in an asset, typically stock, and simultaneously sells or "writes" call option contracts on the same quantity of that asset. This strategy is designed to generate income from the premium received from selling the call option, while the long stock position "covers" the obligation to deliver the shares if the option is exercised. The "covered" aspect means the investor already owns the underlying shares, thus mitigating the unlimited risk associated with selling "naked" call options.

History and Origin

Options have been traded for centuries, but standardized, exchange-traded options, which enable strategies like the covered call, are a relatively modern innovation. The formalization of options trading began with the establishment of the Chicago Board Options Exchange (Cboe) in 1973. Prior to this, options were primarily traded over-the-counter (OTC), often with non-standardized terms and limited liquidity. The Cboe's inception on April 26, 1973, marked a pivotal moment, as it introduced standardized options contracts, which included call options, making strategies like the covered call more accessible and transparent.⁴ This standardization, coupled with the later development of sophisticated pricing models like the Black-Scholes model, facilitated the widespread adoption and understanding of options strategies.

Key Takeaways

• A covered call involves owning shares of stock and selling an equivalent number of call options against those shares.
• The primary goal is to generate income from the premium collected by selling the call option.
• The strategy limits potential upside gains if the stock price rises significantly above the strike price.
• It provides limited downside protection, only to the extent of the premium received.
• Covered calls are generally favored in neutral to moderately bull market environments.

Formula and Calculation

The profit or loss for a covered call strategy can be calculated as follows:

(This occurs if the stock price is at or above the strike price at expiration date.)

(This occurs if the stock price drops to zero.)

The breakeven point is calculated as:

This formula indicates the stock price at which the strategy will neither profit nor lose money.

Interpreting the Covered Call

A covered call strategy is interpreted based on the investor's objectives and market outlook. Investors typically employ this strategy when they expect the underlying asset's price to remain relatively stable or experience only a modest increase. By selling the call option, the investor collects the premium, which can enhance returns in flat markets or provide a small cushion against minor price declines. However, if the stock price significantly surpasses the strike price before expiration, the investor's upside profit is capped at the strike price plus the premium received, as the shares will likely be "called away" (exercised) at that price. This means the investor forfeits any further potential capital gains beyond the strike price.

Hypothetical Example

Consider an investor who owns 100 shares of Company XYZ, purchased at $50 per share. The current market price is also $50. The investor decides to write one covered call option contract (representing 100 shares) with a strike price of $55 and an expiration date one month away, receiving a premium of $2.00 per share (or $200 total).

• Scenario 1: Stock price closes at $52 at expiration.
  The option expires worthless because the stock price ($52) is below the strike price ($55). The investor keeps the 100 shares and the $200 premium. Total gain: $200 (from premium).
• Scenario 2: Stock price closes at $58 at expiration.
  The option is in the money, and the shares are called away at $55 per share. The investor sells the shares at $55 (a $5 gain per share from the purchase price) and keeps the $200 premium. Total gain: ($55 - $50) * 100 shares + $200 premium = $500 + $200 = $700.
• Scenario 3: Stock price closes at $48 at expiration.
  The option expires worthless. The investor keeps the 100 shares and the $200 premium, but the stock has declined in value. Loss on stock: ($50 - $48) * 100 = $200. Net effect: $200 premium - $200 stock loss = $0. The premium offset the stock's decline, resulting in a breakeven.

Practical Applications

Covered calls are widely used by investors seeking to generate income from their existing stock holdings or to slightly reduce the cost basis of a stock. This strategy is particularly common in portfolios focused on income generation, such as those held by retirees or conservative investors. The popularity of options trading, including strategies like the covered call, has seen significant growth in recent years, partly driven by increased retail access and education.³ Financial institutions and fund managers also employ covered call strategies in certain exchange-traded funds (ETFs) and structured products designed to provide consistent yield or mitigate volatility. It serves as a tool for risk management by allowing investors to set a selling price for their shares while collecting current income.

Limitations and Criticisms

While the covered call can be an effective income-generating strategy, it comes with notable limitations. The most significant drawback is that it caps the investor's potential upside profit. If the stock experiences a substantial price increase above the strike price, the investor misses out on those additional gains, as the shares will be exercised at the lower strike price. This opportunity cost can be substantial in strongly rising markets. Additionally, the premium received only provides limited downside protection; if the stock price falls significantly, the investor still incurs losses on the underlying shares, offset only marginally by the premium. Some academic research suggests that, theoretically, covered call writing should not consistently outperform a simple buy-and-hold strategy due to the inherent risk-return trade-off, although practical applications often highlight its income-generating and risk-reducing benefits.² Critics also point out that in a strongly bear market, the small premium collected does little to protect against significant declines in the underlying asset's value.

Covered Call vs. Naked Call

The distinction between a covered call and a naked call is crucial and relates directly to the amount of risk involved.

A covered call significantly reduces the risk for the option seller because the obligation to deliver the shares is "covered" by the shares already held. In contrast, a naked call exposes the seller to potentially unlimited losses if the underlying stock price rises sharply, as they would have to buy the shares at a higher market price to fulfill the delivery obligation at the lower strike price.

FAQs

Q: How does a covered call generate income?
A: A covered call generates income by selling the right, but not the obligation, for another investor to buy your shares at a predetermined strike price before a specific expiration date. In exchange for granting this right, you receive a non-refundable cash payment, known as the premium, upfront.¹

Q: What happens if the stock price goes above the strike price?
A: If the stock price rises above the strike price by the expiration date, the call option will likely be exercised. This means your shares will be "called away," and you will be obligated to sell them at the strike price. Your profit will be limited to the difference between your purchase price and the strike price, plus the premium you received.

Q: Is a covered call a conservative strategy?
A: Compared to simply owning stock, a covered call can be considered a moderately conservative strategy, especially for income generation, as it adds a layer of income and some minor downside protection. However, it still carries the risk of loss on the underlying asset if its price falls significantly, and it caps your potential upside. Investors should understand the risk management aspects before employing it.