Strategy guide
Covered Calls Explained
A covered call is a classic income strategy where you own the stock and sell a call option against it. The goal is to generate premium while staying exposed to the stock's upside up to the strike price.
What is a covered call?
A covered call combines stock ownership with a short call. You collect premium upfront, which can help offset a dip in the stock or add income over time.
It works best when you are neutral to moderately bullish and want to earn income while holding a stock you already own or want to own.
How the trade behaves
- The stock remains your asset, so you still have upside participation.
- The premium adds income to the position.
- Your profit is capped if the stock rises above the strike.
- If the stock falls sharply, the premium may reduce some loss but does not eliminate downside risk.
When investors use it
Covered calls are often used for:
- generating income from a stock position
- managing a mildly bullish outlook
- reducing the effective cost basis of a long stock position
Key risks to understand
Even though the premium helps, a covered call still carries stock risk. If the stock drops materially, the income received may not be enough to offset the loss.
It also limits upside because the option can be assigned if the stock moves above the strike at expiration.
How to analyze this strategy in OTL2
Use OTL2 to model the stock, strike, premium, and expiry before placing or evaluating the trade. Pay attention to the payoff chart, break-even range, and how the strategy changes as time passes.
It is especially useful to compare a covered call against a plain stock position so you can see how income and upside capture change.