A covered call is an options insurance strategy where you simultaneously have an open position on a stock and sell a call option for the same symbol. Adding a short call in your open positions means that you are obligated to sell your stocks at the strike price contingent on the option buyer. However, you already have the stock in your open position, which means you will gain the difference from the long stock and the short call. The combination of those two products creates a payoff that is like a short put. However, the profit is not the same since you spent more on a coverall call versus a short put.
What are its components?
The covered call has two components:
- Long Stock
- Short Call
When and why should I have a covered call?
You should have a covered call if you are moderately bullish on a security and wish to have an extra protection in case the price of the stock goes down. By adding a short call to your stock, you are willing to forego the additional profit should the stock surge for protection if the stock drops in price. This can be seen in the individual profits of these two components, versus the covered call’s profit.
What is the payoff and profit graph?
What is the break-even point?
The break-even point of a covered call can be defined by finding the stock price where the covered call generates a zero-dollar profit. By adding the long stock and the short call together and equating it to zero, you should solve for ST.