Covered Call
A covered call is an options strategy in which an investor who already owns 100 shares of a stock sells one call option against those shares to collect premium income while accepting a cap on upside gains.
The covered call is one of the most widely used and CBOE-endorsed options strategies, considered conservative enough for approval in most standard brokerage accounts. The name 'covered' means the potential obligation to deliver shares is fully 'covered' by the shares already held — unlike a naked call, which carries theoretically unlimited risk. By selling one call contract (representing 100 shares) against each 100-share lot owned, the investor collects the premium immediately and retains the right to keep it regardless of what happens next.
The mechanics are straightforward. Suppose you own 100 shares of a consumer staples company trading at $60 and sell a $65 call expiring in 30 days for a $1.50 premium ($150 total). Two outcomes are possible at expiration. If the stock stays below $65, the call expires worthless and you keep the $150 while retaining your shares. If the stock rises above $65, the call is assigned and you must sell your shares at $65 — missing any gain above that level but having collected the $150 premium. Your maximum profit on the position is thus ($65 - $60) x 100 + $150 = $650.
Covered calls reduce the effective cost basis of a stock position over time. An investor who consistently sells monthly calls and collects premiums is gradually lowering their break-even point. If the original purchase price was $55 and $1.50/month in premiums has been collected for six months, the effective cost basis drops to $46 — meaningful downside cushion against a market decline.
The primary risk of a covered call is 'missing the upside.' If the stock gaps up sharply — say, on a takeover bid — the shareholder is capped at the strike price. The second risk is inadequate downside protection: the premium collected provides only modest buffer against a significant decline. For a $60 stock, a $1.50 premium protects only to $58.50 before losses begin.
Variations include selling covered calls 'in the money' for larger premiums (and greater assignment probability) or rolling the call forward each month to generate ongoing income. Covered calls are a cornerstone of income-oriented options strategies and are frequently combined with dividend reinvestment plans.