What is a covered call strategy and when would you use it?

A covered call is one of the most popular option strategies and a favorite CFA exam topic. It involves:

1. Owning the underlying stock (the "cover")
2. Selling (writing) a call option on that same stock

Why do it?

The primary motivation is to generate income from the option premium in a market where you expect the stock to be flat or modestly bullish. You're essentially renting out the upside of your stock position.

Payoff profile:

• Maximum profit: (Strike price - Purchase price) + Premium received
• Maximum loss: Purchase price - Premium received (stock goes to zero)
• Breakeven: Purchase price - Premium received

Example:

You own 100 shares of Beacon Energy, purchased at $80/share. You sell a call with a$90 strike for a $4 premium.

Stock Price at Expiry	Stock P/L	Option P/L	Net P/L
$70	-$10	+$4 (expires worthless)	-$6
$76	-$4	+$4	$0 (breakeven)
$80	$0	+$4	+$4
$90	+$10	+$4 (assigned at strike)	+$14 (max profit)
$100	+$10*	+$4 -$10 = -$6	+$14 (capped)

*At $100, you must sell at$90 (assigned), so stock gain is capped at $10.

Key insights:

1. Income generation: The $4 premium provides income even if the stock doesn't move
2. Downside cushion: The premium partially offsets losses (breakeven drops from $80 to$76)
3. Capped upside: You give up gains above the strike price — if Beacon Energy surges to $120, you still sell at$90

When it makes sense:

• You're neutral to slightly bullish
• You want income from a stock you plan to hold anyway
• You're willing to sell at the strike price

When it doesn't make sense:

• You're very bullish (you'd miss the upside)
• The stock is extremely volatile (large downside risk only partially offset by premium)

For more options strategies, check out our CFA Level I derivatives materials.