The covered call

A covered call is owning 100 shares of a stock and selling one call against them. It is the most common income strategy and a sensible entry point into options selling because the share holding "covers" the obligation.

The structure

Own 100 shares at 100
Sell 1 call, strike 105, collect premium 2.00

The payoff

You keep the 2.00 premium no matter what. Then:

• Stock stays below 105: the call expires worthless, you keep the premium and the shares. You have effectively earned a 2% yield on the position.
• Stock rises above 105: you are assigned — your shares are called away at 105. You still profit (5 of stock gain + 2 premium = 7) but you gave up everything above 105.
• Stock falls: the 2.00 premium cushions the loss slightly, but you still own the falling shares.

When to use it

Use a covered call when you are neutral to mildly bullish and happy to sell at the strike. It generates income from a holding you would own anyway.

Honest risk

The covered call does not protect you on the downside — if the stock crashes, you own all of it minus the small premium. And you cap your upside at the strike: in a big rally you watch the stock run away above 105 while your shares are sold at 105. You are trading away the tail in exchange for steady premium. That bargain is fine when you understand it and a disappointment when you do not.