HOME ABOUT ARCHIVES MASTERCLASS BLOG SUBSCRIBE   SIGN IN

Bullish Patterns
Long Calls
Bull Call Spread
Bull Put Spread
Call Backspread
Long Call Ratio Spread
Naked Put
Synthetic Long Stock
The Collar
Covered Calls
Synthetic Long Call
Synthetic Short Put
Covered Straddle
Covered Strangle
Married Put
Protective Put

Bearish Patterns
Long Puts
Bear Put Spread
Bear Call Spread
Put Backspread
Long Put Ratio Spread
Naked Calls
Synthetic Short Stock
Synthetic Short Stock (split strikes)
Covered Put
Protective Call
Synthetic Short Call
Synthetic Long Put

Long Volatility
Long Straddle
Long Strangle
Short Call Butterfly
Short Put Butterfly
Short Iron Butterfly
Short Call Condor
Short Put Condor
Short Iron Condor
Long Guts
Strip
Strap
Short Call Ladder
Short Put Ladder
Long Call Synthetic Straddle
Long Put Synthetic Straddle

Short Volatility
Short Straddle
Short Strangle
Long Call Butterfly
Long Put Butterfly
Long Iron Butterfly
Long Call Condor
Long Put Condor
Long Iron Condor
Short Guts
Long Call Ladder
Long Put Ladder
Call Ratio Spread
Short Call Ratio Spread
Put Ratio Spread
Short Put Ratio Spread
Ratio Call Write
Ratio Put Write
Short Call Synthetic Straddle
Short Put Synthetic Straddle
Variable Ratio Write

print this page
send to a friend

Covered Calls

Risk: low
Reward: low

General Description
Entering a covered call entails selling calls against a long stock position.

(draw a covered call risk diagram here)

The Thinking
There are two main purposes of this strategy. 1) You're long a stock and want to generate monthly or quarterly cash flow while maintaining ownership of the stock. You sell out-of-the-money calls against your position. As long as the stock closes below the strike price at expiration, you keep the stock and can sell calls again. Collecting a couple % each month or quarter adds up; it's like collecting a monthly or quarterly dividend. 2) You buy a stock specifically for the purpose of selling calls, and while it may be nice for the stock to close just below the strike at expiration so you can sell calls again, you're perfectly ok with the stock rallying and getting called from you. This is typically done with a volatile stock which fetches a high premium.

Example
You've been the proud owner of 1000 shares of XYZ for several years. It's a quiet stock which has treated you well, but you'd like to use covered calls to generate a little cash flow. The stock is at $42. You sell (10) 45 calls for $1.00 each.

As long as the stock closes below $45 on expiration day, you keep the call premium and the stock. But if the stock were to rally above $45, the stock would get “called” from you unless you bought the calls back before they expired.

The PL chart below graphically shows where this trade will be profitable and at a loss.