GRIP Financial Planning: Growth, Retention, Income, Protection

Options Blueprint

Covered calls

Earn premium on shares you own, in exchange for capping your upside.

Beginner Income

Important: educational only. Options Blueprint is general financial education, not advice or a recommendation to use any strategy. Options involve significant risk and are not suitable for all investors. Some strategies can lose more than the premium received or paid, and some have unlimited potential losses. Before buying or selling an option, investors must receive and read the OCC’s Characteristics and Risks of Standardized Options. All “Stock XYZ” examples are made up and ignore fees and taxes. Read the full risk disclosure.

Goal Earn extra income on shares you already own, in exchange for capping your upside.

How it works with Stock XYZ

Setup: You own 100 shares of XYZ bought at $50 ($5,000). You sell one 30-day $55 call for $1.00 and collect $100 right away. Results are shown at expiration, per 100-share contract, ignoring fees, dividends and taxes.

  • XYZ below $55 at expiration: the call expires worthless. You keep the $100 and your shares, and could do it again next month.
  • XYZ above $55: your shares are “called away” at $55. You receive $5,500 for shares that cost $5,000, plus the $100 you kept: a total gain of +$600, even if XYZ went to $70.
  • XYZ falls to $40: the shares lose $1,000, the call expires worthless, and the net result is −$1,000 + $100 = −$900.
Payoff of a covered call: 100 XYZ shares bought at $50 plus a $55 call sold for $1.00The strategy line rises one for one from minus $1,900 at XYZ $30, crosses $0 at the $49 breakeven, and reaches plus $600 at $55. Above $55 it is flat at plus $600. The dashed stock-only line runs from minus $2,000 at $30 to plus $2,000 at $70 and crosses the covered-call line at $56. Below $56 the covered call does better; above $56 the shares alone do better.$30$40$50$60$70−$2,000−$1,000$0+$1,000+$2,000XYZ price at expirationProfit / loss per contractHypothetical · ignores feesMax gain +$600(XYZ $55 or above)Breakeven $49XYZ $40: −$900Stock only
Covered call: 100 XYZ shares at $50 plus a $55 call sold for $1.00. The dashed line is the shares alone. Below $56 the covered call does better than the shares alone (by up to $100); above $56 the shares alone do better. At $56 both are +$600.
Covered call: max gain, max loss and breakeven
At expirationPer sharePer contract (×100)
Max gain($55 − $50) + $1.00 = $6.00+$600
Max loss$50 − $1.00 = $49.00 (if XYZ goes to $0)−$4,900
Breakeven$50 − $1.00 = $49.00

Key risks

  • Capped upside. If XYZ jumps to $70, you still sell at $55. You give up the ($70 − $55) × 100 = $1,500 of gains above the strike. Counting the $100 you kept, you end up $1,400 behind simply holding the shares (+$600 vs. +$2,000).
  • Stock risk stays. The premium only cushions a drop by $1.00 a share. It is not protection.
  • Assignment, including early. You can be assigned before expiration, especially when the call is in the money just before an ex-dividend date (the buyer may exercise to collect the dividend).
  • Taxes. Having shares called away is a sale and may trigger capital gains, and some covered calls can affect holding periods. The rules are detailed; talk to a tax professional.
  • Gap risk. Stocks can gap down overnight on news, and the covered call does little to help.

What can go wrong: a sharp drop

XYZ reports bad news and opens at $40. The $55 call is nearly worthless, so the $100 premium is all the help you get: the position is down −$900 at expiration (−$1,000 on the shares + $100). If you then sell another call at a strike below your $49 breakeven and get assigned, you would lock in a loss.

Who tends to use it

Long-term holders who would be okay selling at the strike price and want some income from a flat or slowly rising stock. Covered calls are often allowed at a broker’s lowest options level and often in IRAs, but rules vary by broker.

Related glossary terms

Related Options Blueprint topic

  • Covered Calls: Getting Paid While You Wait

We’ll cover these topics in the future. See all Options Blueprint topics.

Important: please read

Educational only. Options Blueprint is general financial education. It is not financial, investment, tax or legal advice, and it is not a recommendation to buy or sell any security or to use any strategy. Nothing here is personalized to you, and viewing it doesn’t create an advisory relationship.

Options are not suitable for everyone. Options are complex and carry significant risk. They can lose money quickly, including the full amount you paid. Some strategies can lose more than the premium received or paid, and some (such as selling uncovered calls) have unlimited potential losses. Assignment can happen at any time before expiration on most stock and ETF options, and prices can gap sharply on news.

Hypothetical examples only. “Stock XYZ” and all prices, premiums and results on this page are made up for illustration. They ignore commissions, fees, bid/ask spreads, dividends, interest, margin requirements and taxes, all of which affect real results. No real tickers are used, and nothing here is a trade recommendation.

Read the official disclosure first. Before buying or selling an option, investors must receive and read the Options Clearing Corporation’s Characteristics and Risks of Standardized Options (the “Options Disclosure Document”), available from your broker or directly from the OCC.

Read the Options Disclosure Document (OCC)

Free investor education from the SEC: Investor Bulletin: An Introduction to Options and Investor Bulletin: Opening an Options Account. To check a professional’s background, see FINRA BrokerCheck.

Talk to a qualified professional before making investment decisions. See our full Disclosures.