Covered calls
A covered call trades away upside above a chosen price in return for cash today.
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Mechanics
Own 100 shares, sell one call option with a strike above the current price. The buyer pays a premium. If the stock ends below the strike, you keep shares and premium. If it ends above, the shares are called away at the strike.
max profit = (strike − purchase price) + premium break-even = purchase price − premiumWho uses it
Income-oriented investors and funds that track buy-write indices such as the CBOE S&P 500 BuyWrite Index (BXM). Historically BXM delivered returns close to the index with lower volatility, while lagging badly in strong rallies.
The trade-off
The premium only partly cushions a fall: the full downside of the stock remains. A covered call is not a hedge; it is a sale of upside.
Practice
Three quick tasks. Pick an answer to check it, or open the answer below each task.
Bought at 100, sold a 105 call for 2.50. What is the maximum profit per share?
Show answer
7.50. (105 - 100) + 2.50 = 7.50.
Same position: what is the break-even price?
Show answer
97.50. 100 - 2.50 = 97.50.
Is a covered call a hedge against a crash?
Show answer
Only partly: the premium cushions a small part of the fall. You keep almost all of the downside.
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