COVERED CALLS OVERVIEW

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This Strategy involves buying the underlying and selling a Call Option for the same number of Underlying units.

 

Covered calls are similar in payout to selling a fully funded Put for the same strike; after taking into account dividends.

 

 

Selling covered calls foregoes any appreciation potential beyond the strike in exchange for the premium. Net of the Intrinsic Value, the most premium is obtained at or around the At the Money Strike. The resulting covered call position has Lower volatility compared to a pure long position as the range of potential payouts is reduced.

 

Further risk reduction can be achieved by selling an in the money strike – which results in increasing the distance to negative payouts for the combined strategy.

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Covered calls are not a capital preservation strategy as positions can significantly depreciate below the strike. They are not a levered position, as they usually move slower than the underlying and are mildly bearish as they forgo potential appreciation.

 

Some common uses of covered calls are income generation, exiting of positions, volatility reduction, monetization of high implied volatility and monetization of high time value of money for low strikes.

 

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Covered Call Payout Example.

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The example below illustrates the payout of a Covered Call, consisting of the combination of a long stock position and a short call – for the equal units of underlying.

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The net amount invested in the covered call is $94, providing a small amount of leverage per unit of underlying. The call in the example has a $100 at the money strike and a $6 premium.