The Covered Call Strategy
Covered calls, also called "Covered calls", are very often used by hedge funds or certain very experienced individual traders.
A covered call is an options strategy where the investor buys (or already holds) a long position in a stock or other asset and sells call options on that same asset.
What are the characteristics of the covered call option issuance strategy?
Maximum profit: (short call strike price + call premium received - stock purchase price) x 100 (the number of underlying securities. There are usually 100 of them, but this is not always the case).
Maximum loss: (stock purchase price - call premium received) x 100
Break-even at expiration: purchase price of the stock - call premium received
Estimated probability of winning: more than 50%, provided that the short calls are out-of-the-money at the time they are issued, with a delta less than +0.50. The short calls are therefore in the interval [0, + 0.5]. In this case, the probability of ending in-the-money (= potential loss) is less than 50%, so the transaction will be profitable in more than 50% of cases.
Position after expiration: If the stock price is higher than the strike price of the short call, the shares of the writer of the covered call are "claimed." If the stock price at expiration of the call option is lower than the strike price of the short call, the call option expires worthless, and the investor keeps the shares and the premium received for writing the call.
Delivery Obligation Risk: If the short call is in-the-money, the covered call writer runs the risk of having to deliver 100 shares per call option contract. But since the investor holds 100 shares (long position) per short call, these shares are "claimed," leaving the investor with no position.
Let's explain it with numbers:
an example of calculation
Purchase price of the share: €75
Strike price of the short call sold: €80
Premium received for call 80: €3.00
Maximum gain:
(€80 short strike price + €3 premium received - €75 share purchase price) x 100 = €800
Maximum loss:
(€75 purchase price of the share + €3 premium received) x 100 = €7,200 (the share price falls to €0)
Break-even price at expiration
(effective purchase price of the share):
€75 purchase price of the share + €3 premium received = €72
Position in case of delivery obligation:
If the short 80 call is delivered, the covered call writer is obligated to sell 100 shares at the strike price. Since the investor already owns the 100 shares, the delivery obligation leaves them without a position. The upside is that the covered call writer receives the maximum profit.
P/L chart at expiration: covered call vs. long equity position (source: Capital Hedge)
