Covered Call Strategy
The covered call strategy is one of the most popular options strategies for income generation. It's particularly suitable for beginners as it combines stock ownership with options trading in a relatively low-risk way.
Strategy Overview
Risk/Reward Profile
Premium received + (Strike price - Stock purchase price)
Stock purchase price - Premium received
Stock purchase price - Premium received
Strategy Setup
When to Use This Strategy
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When you own a stock and want to generate additional income
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When you're willing to sell your stock at the strike price
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When you have a neutral to slightly bullish outlook on the stock
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When implied volatility is high (higher premiums)
Risks to Consider
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Limited upside potential (capped at strike price)
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Stock price could fall below break-even point
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Early assignment risk if stock price rises significantly
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Opportunity cost if stock price rises above strike price
Note: This strategy explanation is for educational purposes only. Always do your own research and consider your risk tolerance before trading.
Example Trade
Lloyds Bank (LLOY) Covered Call
Current stock price: £45.00
Sell £47.50 call option (30 days to expiration)
Premium received: £1.20 per share
Trade Analysis:
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Maximum profit: £3.70 per share (£47.50 - £45.00 + £1.20)
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Break-even point: £43.80 (£45.00 - £1.20)
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Maximum loss: £43.80 per share (if stock goes to zero)
Strategy Management
Rolling the Position
If the stock price approaches the strike price, you can roll the position by buying back the current call and selling a new call with a higher strike price and later expiration.
Early Assignment
If your call option is assigned early, you'll need to sell your shares at the strike price. This is not necessarily a bad outcome, as you've achieved your maximum profit.
Adjusting for Market Changes
If the stock price falls significantly, you can buy back the call at a profit and either sell a new call at a lower strike or hold the stock without a covered call position.
Important: While covered calls are considered a relatively conservative strategy, they still involve risk. Make sure you understand the strategy fully and are comfortable with the potential outcomes before trading.