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"Owning shares of a stock and selling Covered Calls is half as risky as just owning the stock" - Value Line Survey, New York

A covered call is a strategy in which you write a call option contract while at the same time own an equal number of shares of the underlying stock. Covered calls are realized as the most basic and most widely used strategy combining the flexibility of options with stock ownership.

Market Opinion

Neutral to Bullish on the Underlying Stock

When to Use

Covered calls can be used in any market, but they're most often used when one is bullish on the underlying stock, but feels the market value of the stock will undergo little change over the lifetime of their option. Most often an investor is seeking either additional income (other than the dividends) from shares of the underlying stock, and/or to provide a limited amount of protection against a decline in the stock's value.

Benefit

A covered call can offer limited protection from a decline in price of the underlying stock but can limit profit gained with an increase in stock price. The covered call also generates immediate income because you keep the premium received from writing the call. At the same time, you still receive all the benefits of underlying stock ownership, such as dividends and voting rights, unless assigned an exercise notice on the written call and the obligation to sell your shares. The covered call is widely regarded as a conservative strategy because it generally decreases the risk of stock ownership.

Risk vs. Reward

Maximum Profit: Limited

Maximum Loss: Substantial

Upside Profit at Expiration if Assigned: Premium Received + Difference (if any) Between Strike Price and Stock Purchase Price

Upside Profit at Expiration if Not Assigned: Any Gains in Stock Value + Premium Received

Your maximum profit will occur if the price of the underlying stock you own is at or above the call option's strike price, either at its expiration or when you might be assigned an exercise notice for the call before it expires. Your risk of real financial loss comes from the shares of stock held. This loss can become substantial if the stock price continues to decline in price as the written call expires. At the call's expiration, the loss can be calculated as the original purchase price of the stock less its current market price, less the premium received from initial sale of the call. Any loss accrued from a decline in stock price is offset by the premium you received from the initial sale of the call option. As long as the underlying shares of stock are not sold, this would be an unrealized loss. You will hold the shares until the market price agrees with you and then sell - while being able to write additional covered calls using the shares. Assignment on a written call is always possible.

Break-Even-Point

Stock Purchase Price - Premium Received

Volatility

If Volatility Increases: Negative Effect

If Volatility Decreases: Positive Effect

Any effect of volatility on the option's price is on the time value part of the option's premium.

Time Decay

Passage of Time: Positive Effect

As time passes, the time value part of the option's premium generally decreases - a positive effect for one with a short option position.

Alternatives before expiration

If your opinion on the underlying stock changes significantly before the written call expires, whether more bullish or more bearish, you can make a closing purchase transaction of the call in the marketplace. This would close out the written call contract, relieving you of your obligation to sell your stock at the call's strike price. Before taking this action, you should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If your written call position is closed out in this manner, you can decide whether to make another option transaction to either generate income from and/or protect your shares, to hold the stock unprotected with options, or to sell the shares.

Alternatives at expiration

As expiration day for the call option nears, you consider three alternatives and then accordingly make a decision. The written call contract will either be in-the-money, at-the-money or out-of-the-money. If you feel the call will expire in-the-money, you can choose to be assigned an exercise notice on the written contract and sell an equivalent number of shares at the call's strike price. Alternatively, you can choose to close out the written call with a closing purchase transaction, canceling your obligation to sell stock at the call's strike price, and retain ownership of the underlying shares. Before taking this action, again, you should weigh any realized profit or loss from the written call's purchase against any unrealized profit or loss from holding shares of the underlying stock. If you feel the written call will expire out-of-the-money, no action is necessary. You can let the call option expire with no value and retain the entire premium received from its initial sale. If the written call expires exactly at-the-money, you should realize that assignment of an exercise notice on such a contract is possible, but should not be assumed. Always consult with your brokerage firm or a financial advisor on the advisability of what action to take whatever your case.

The main focus of All In The Money is covered calls. The following tutorials, information, tools and daily analyst option selections can help you generate returns of 10% to 25% and more every month.