What a covered call is
A covered call combines two pieces: owning shares and selling a call against them. You receive a premium for agreeing to sell your shares at the call’s strike price through expiration.
The premium is income. In exchange, you cap your upside above the call strike. If the stock rises above the strike, you agreed to sell at the strike - so you keep the premium but miss out on gains above that price.
Payoff at expiration
What you get and what you give up
You receive
- Premium income, paid up front
- A slightly lower breakeven on the shares
You give up
- Upside above the call strike (your gain is capped)
- The shares are still exposed to downside losses
How the downside cushion works
The option premium you receive creates a downside cushion. If the stock declines, that income offsets the first portion of the loss before your position falls below its initial value.
A covered call therefore provides limited protection, but it does not establish a floor or protect against a large decline. Once the stock falls beyond the cushion, additional losses continue with the share price.
Risks to understand
- Assignment: The short call can be assigned, particularly when it is in the money. If assigned, you would sell your shares at the strike price.
- Losses beyond the cushion: Option income and estimated dividends absorb only the first portion of a decline. Losses continue if the stock falls further.
- Opportunity cost: If the stock rises above the call strike, your gains are capped and you give up additional upside.