What Is a Covered Call?

The covered call is a neutral to slightly bullish options trading strategy created by:

• ✅ Purchasing 100 shares of a stock or ETF
• ✅ Selling 1 call option

The covered call is an excellent strategy for traders to earn extra income from stock in a neutral market. Because you own the stock, risks are mitigated, making it an ideal strategy for traders starting with options. 

The most significant downside of a covered call is that it caps your upside potential. If you only own the stock, your profits are theoretically unlimited. However, when you sell a call against your stock, your upside is limited to the strike price plus the premium received.

For example, if you own ABC stock at $100 and sell a 105 call for $3, your maximum profit is limited to $8 per share ($5 from stock appreciation + $3 from the option premium received).

Covered Call: Payoffs

• Breakeven Price: Stock purchase price - premium received
• Maximum Profit: (Strike price - stock purchase price) + premium received‍
• Maximum Loss: Net stock cost after premium

Why Use A Covered Call?

You should use the covered call strategy if you are market-neutral on the underlying asset. Short call options benefit from theta decay—assuming all else remains equal, with each passing day, call options (and puts) shed value.

If the underlying asset stays flat or declines, the out-of-the-money call you sold will expire worthless, allowing you to keep the premium. This makes covered calls an income-generating strategy. After the option expires, you can sell another call option at a different expiration and repeat the process until either of the following happens:

1. The stock rises above the strike price, your option is assigned, and your shares are called away, leaving you with no position.
2. You become bullish and stop selling calls to keep the stock's upside potential.

How Do You Place a Covered Call?

You can either leg into a covered call by buying the stock and then selling the call or enter the trade in one step. The TradingBlock platform makes this easy with its option templates:

If you are legging into a covered call, buying the stock first and then selling the call option is the best way to go about it. If you sell the call first, you will have a significant margin requirement and unlimited upside risk as the stock has no ceiling. 

What Call Should I Sell?

Determining the strike price of the call you sell depends entirely on your market outlook and whether you're comfortable having your stock called away.

There is a risk-reward dynamic with moneyness:

• The further out-of-the-money (OTM) the call, the lower the premium received, but the more upside you retain if the stock rises.
• An at-the-money (ATM) or near-ATM call collects more premium but has a higher chance of being assigned.

Most traders sell out-of-the-money (OTM) calls, as this strategy allow for some stock upside while still collecting premium. Keep in mind that selling at the money calls come with a 50/50% chance of option assignment.

Managing Covered Calls & Assignment Risk

The closer your sold call is to being in the money, the greater the chance of early assignment. This risk intensifies when:

• The call option is deeply in the money
• The option has little to no extrinsic value
• There is an upcoming dividend

To avoid assignment on your call (which would result in losing your stock and having no position), you can either close the call or roll it to a higher strike price.

You can buy back your call and sell your new call in one trade, a vertical spread. If you need more time, roll your call option to a different expiration cycle in a calendar spread.

Short Calls and Time Decay (Theta)

As we mentioned before, short options benefit from time decay, which accelerates as expiration approaches. Time decay picks up around 60 days until expiration (DTE) and then accelerates exponentially.

In the bear market example above, watch how the option's decline in value gradually allows our covered call position to outperform simply holding the stock.

To see how much your short call option is expected to shed daily, you can check the option Greek theta on the TradingBlock platform.

Short Calls and Margin Requirements

Selling a covered call against long stock you own requires no additional costs or margin. 

If you buy 100 shares at $100 per share, your total (margin free) cost is:

• Stock cost: 100 × $100 = $10,000

If you sell a $105 call for $2, you receive $200 in premium (since options contracts cover 100 shares).

• Net cost with the covered call: $10,000 - $200 = $9,800

While the covered call doesn’t lower the actual cost of holding the stock, it offsets part of the cost with the premium you collect.

Covered Call: Trade Example #1

Let’s jump to a real-world covered call example. 

SPY (SPDR S&P 500 ETF Trust) trades at $569/share. We expect it to stagnate around this range over the next few months, so we decide to sell the $580 call expiring in 88 days for $4.24 while purchasing 100 shares of stock at $569.

Here are our trade details:

• Underlying asset: SPY 
• Current stock price: $569
• Stock purchased: 100 shares at $569
• Option sold: $580 call
• Premium received: $4.24 per contract ($424 total)
• Strike price: $580
• Expiration: 88 days
• Net cost: $569 - $4.24 = $564.76 per covered call

Trade Result

88 days have passed, and SPY is trading at $570, just one dollar higher than where it was when we put the trade on. Here’s how our covered call played out:

• Stock price: $569 → $570
• Option price: $4.24 → $0
• Profit from stock: +1 per share ($100 total)
• Profit from call premium: +4.24 per share ($424 total)
• Total profit: $524

Though it started a little bumpy, this was an ideal market environment for a covered call. The stock only moved up $1, which was not enough to interfere with the call we sold, so we pocketed the full $4.24 premium and picked up another $100 from the stock.

Notice how the gap between the stock price and the covered call price widens as the call option loses value, leading to the covered call outperforming.

Covered Call: Trade Example #2

In this SPY trade example, we will take the same trade as before and switch up the outcome. Here are our trade details again:

• Underlying asset: SPY 
• Current stock price: $569
• Stock purchased: 100 shares at $569
• Option sold: $580 call
• Premium received: $4.24 per contract ($424 total)
• Strike price: $580
• Expiration: 88 days
• Net cost: $569 - $4.24 = $564.76 per covered call

Trade Results:

So in this trade, SPY skyrocketed from $569 all the way to $600, blasting past our short strike price. 

In the real-world, our short call option probably would have been assigned before expiration, but for this example we're going to say it was not.

Here’s where we ended:

• Stock price: $569 → $600
• Option price: $4.24 → $20
• Profit from stock: +$31 per share ($3,100 total)
• Loss from call: -$15.76 (-$1576 total)
• Total profit: $3,100 (stock profit) - $1,576 (option loss) = $1,524

Our ideal closing price for SPY would have been $580. This way, we would have collected the full premium from the option while making $11 per share ($1,100 total) from the stock.

But the stock went all the way up to $600. Because of our short call, our max profit on this trade is capped at $1,524.

Even though SPY hit $600, any stock gains above $580 are fully offset ($1 gained in stock = $1 lost in the short call), locking in our max profit at $1,524.

Covered Calls and The Greeks

The table below shows the relationship of covered calls and the option Greeks.

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⚠️ Besides the initial debit paid or margin, it is essential to consider the commissions and fees associated with most options transactions when calculating net profit or loss. These fees can significantly impact the overall return on investment and should be factored into all trades placed. Be sure to read Characteristics and Risks of Standardized Options before trading options.