Covered Call

Shares held with a call written against them: the credit adds to the return while the share price stays below the strike, and any gain above it is given up.

Also called Buy write, Covered write

Outlook

Bullish

Family

Income

Level

Novice

Legs

2 legs

Expirations

1 expiration

Opens for

Debit

Maximum profit

Limited

Maximum loss

Limited

Requires shares

Yes

Legs at the reference strikes this page's diagrams are drawn from

Leg	Side	Contract	Ratio	How the strike is chosen
	Long	Shares	1
B	Short	Call 105	1	Delta 30

What it is

100 shares held, and one call written against them at B. The call brings in a credit now; in exchange, if the shares finish above B they are called away at B and the gain above that strike belongs to the buyer of the call.

The word covered is doing real work. The obligation to deliver shares is met by shares already held, which is what separates this from a short call — the same option, written without the stock, with an unbounded loss. Here the shares are the cover, and the worst case is the same worst case the shares already had.

The payoff

At expiration

A rising line that flattens at the short call strike: the position tracks the shares below B and is capped at its maximum above it.

Two regions:

• Below B — the call expires worthless. The position is the shares plus the credit, so it tracks the stock with a head start equal to the premium.
• Above B — the shares are called away at B. The result is fixed at (B − entry price) plus the credit, however far the price runs.

Break-even is the share entry price minus the credit. The credit lowers the break-even by exactly what it pays, which is the whole of the downside benefit: it is a buffer, not a floor.

How it behaves before expiration

Today, before expiration

Today's value is a shallow curve, above the expiration line below the strike and below it above the strike, with the corner at B rounded.

The corner at B is rounded rather than sharp. Below the strike the position is worth more than its terminal value, because the short call still carries time value that has not yet been earned; above the strike it is worth less, because that same time value is a liability that must be bought back.

That is why a covered call deep in the money does not show its full result until expiry: the gain is capped and already earned, but the option cannot be closed for its intrinsic value alone until there is no time left in it.

The Greeks

Delta is positive but less than the 100 of the shares alone — the short call subtracts its own delta. A call written at 30 delta leaves the position behaving like roughly 70 shares.

Gamma is negative, concentrated around B. As the price rises toward the strike the position’s delta falls, so it participates less and less in the move.

Theta is positive: the short call decays in the holder’s favour, and the shares contribute nothing either way.

Vega is negative. A rise in implied volatility makes the written call more expensive to buy back, and the shares do not respond.

Where it lives in the volatility environment

Practitioners generally describe the covered call as a way to convert some of a holding’s expected upside into current income, and observe that the credit for a given strike and expiry is larger when implied volatility is high. The size of the credit does not change where the cap sits: that is fixed by the strike.

What can go wrong

• Early assignment before an ex-dividend date. A call that is in the money with less extrinsic value than the dividend is a candidate for early exercise, and the shares leave before the dividend is captured.
• The cap is real. A takeover or a gap above B ends the position at B, and the shares are gone at that price.
• It is not downside protection. The credit lowers the break-even by its own size and no further; below that the position loses like the shares.
• Closing the call and keeping the shares is a choice with a cost. Buying back a call that has moved against the position realises a loss on that leg even though the shares have gained.
• Assignment leaves no shares. Any plan for the position after the call is assigned has to start from cash, not from stock.

Building it in Option Panel

Open Build Strategy and pick Covered Call. The structure requires stock, so the trade must already hold at least 100 shares per contract — the builder refuses rather than inventing a share leg, and says which quantity is missing.

The short call at B can be chosen by delta, by percentage or points from the price, by an offset from the share price, or as an exact strike.

Back to the encyclopaedia · What-if analysis in the docs

Related strategies

• Long Stock — the position this one starts from, with nothing written against it.
• Short Put — the same payoff shape built from one option and no shares.
• Collar — this position with a floor bought under it, paid for by this credit.