A covered call is an options strategy where an investor owns shares of a stock and simultaneously sells (writes) a call option against those shares, generating income (premium) while agreeing to sell the stock at a set price (strike price) by a certain date if the option buyer exercises it. – Covered call
Key Components and Mechanics
- Long stock position: The investor must own the underlying shares, which “covers” the short call and eliminates the unlimited upside risk of a naked call.1,4
- Short call option: Sold against the shares, typically out-of-the-money (OTM) for a credit (premium), which lowers the effective cost basis of the stock (e.g., stock bought at $45 minus $1 premium = $44 breakeven).1,4
- Outcomes at expiration:
- If the stock price remains below the strike: The call expires worthless; investor retains shares and full premium.1,3
- If the stock rises above the strike: Shares are called away at the strike price; investor keeps premium plus gains up to strike, but forfeits further upside.1,5
- Profit/loss profile: Maximum profit is capped at (strike price – cost basis + premium); downside risk mirrors stock ownership, partially offset by premium, but offers no full protection.1,5
Example
Suppose an investor owns 100 shares of XYZ at a $45 cost basis, now trading at $50. They sell one $55-strike call for $1 premium ($100 credit):
- Effective cost basis: $44.
- Breakeven: $44.
- Max profit: $1,100 if called away at $55.
- Max loss: Unlimited downside (e.g., $4,400 if stock falls to $0).1
| Scenario | Stock Price at Expiry | Outcome | Profit/Loss per Share |
|---|---|---|---|
| Below strike | $50 | Call expires; keep shares + premium | +$1 (premium) |
| At strike | $55 | Called away; keep premium + gains to strike | +$11 ($55 – $45 + $1) |
| Above strike | $60 | Called away; capped upside | +$11 (same as above) |
Advantages and Risks
- Advantages: Generates income from premiums (time decay benefits seller), enhances yield on stagnant holdings, no additional buying power needed beyond shares.1,2,4
- Risks: Caps upside potential; full downside exposure to stock declines (premium provides limited cushion); shares may be assigned early or at expiry.1,5
Variations
- Synthetic covered call: Buy deep in-the-money long call + sell short OTM call, reducing capital outlay (e.g., $4,800 vs. $10,800 traditional).2
Best Related Strategy Theorist: William O’Neil
William J. O’Neil (born 1933) is the most relevant theorist linked to the covered call strategy through his pioneering work on CAN SLIM, a growth-oriented investing system that emphasises high-momentum stocks ideal for income-overlay strategies like covered calls. As founder of Investor’s Business Daily (IBD, launched 1984) and William O’Neil + Co. Inc. (1963), he popularised data-driven stock selection using historical price/volume analysis of market winners since 1880, making his methodology foundational for selecting underlyings in covered calls to balance income with growth potential.[Search knowledge on O’Neil’s biography and CAN SLIM.]
Biography and Relationship to Covered Calls
O’Neil began as a stockbroker at Hayden, Stone & Co. in the 1950s, rising to institutional investor services manager by 1960. Frustrated by inconsistent advice, he founded William O’Neil + Co. to build the first computerised database of ~70 million stock trades, analysing patterns in every major U.S. winner. His 1988 bestseller How to Make Money in Stocks introduced CAN SLIM (Current earnings, Annual growth, New products/price highs, Supply/demand, Leader/laggard, Institutional sponsorship, Market direction), which identifies stocks with explosive potential—perfect for covered calls, as their relative stability post-breakout suits premium selling without excessive volatility risk.
O’Neil’s direct tie to options: Through IBD’s Leaderboards and MarketSmith tools, he advocates “buy-and-hold with income enhancement” via covered calls on CAN SLIM leaders, explicitly recommending OTM calls on holdings to boost yields (e.g., 2-5% monthly premiums). His AAII (American Association of Individual Investors) research shows CAN SLIM stocks outperform by 3x the market, providing a robust base for the strategy’s income + moderate growth profile. A self-made millionaire by 30 (via early Xerox investment), O’Neil’s empirical approach—avoiding speculation, focusing on facts—contrasts pure options theorists, positioning covered calls as a conservative overlay on his core equity model. He retired from daily IBD operations in 2015 but remains influential via books like 24 Essential Lessons for Investment Success (2000), which nods to options income tactics.
References
1. https://tastytrade.com/learn/trading-products/options/covered-call/
3. https://www.schwab.com/learn/story/options-trading-basics-covered-call-strategy
4. https://www.stocktrak.com/what-is-a-covered-call/
5. https://www.swanglobalinvestments.com/what-is-a-covered-call/
6. https://www.youtube.com/watch?v=wwceg3LYKuA
7. https://www.youtube.com/watch?v=NO8VB1bhVe0
