Lesson 15 of 25 · 6 min

A covered call: the premium and the cap

Cash arrives now, and the shares become shares you may be required to hand over at a price fixed today.

A covered call is the other single-leg structure, and it moves the distribution in the opposite direction from a put. Premium is received rather than paid, and the outcome is capped rather than floored.

Take 6,800 shares at $147.25, so $1,001,300, and a call struck at $165 with 118 days to expiry at $6.40 per share. The premium received is 6,800 × $6.40 = $43,520, which is 4.35 percent of position value. Track 2 lesson 14 established what covered means: the delivery obligation is pre-satisfied by the shares, so no cash is required to perform it.

At expiry, above $165 the shares are called away at $165. The best outcome is 6,800 × $165 = $1,122,000 plus the $43,520 premium, which is $1,165,520, or 16.40 percent above the starting $1,001,300. If the price reaches $190, the appreciation forgone is 6,800 × ($190 − $165) = $170,000. Below $165 the shares stay and the premium remains, so a decline is cushioned by 4.35 percent and no more.

For a pledged position the second effect matters as much as the first. Assignment removes the shares from the pledged account and replaces them with $1,122,000 of cash, which usually carries a much higher advance rate — but the concentrated holding is gone, at a price fixed months earlier, on a date chosen by whoever holds the call. That is a disposal the borrower did not time, with the tax consequences Track 1 lesson 18 described for any sale.

Key terms

Covered call: Holding shares while writing a call on them, so the obligation to deliver at the strike is already satisfied by the shares held.
Cap: The strike, functioning as a ceiling on the value the shares can produce for you at expiry.
Assignment: The moment the call holder exercises and the shares must be delivered. The timing is the holder's choice, not yours.

Worked example

The ceiling and what sits above it

6,800 shares at $147.25, so $1,001,300. One call written per 100 shares, struck at $165, 118 days, $6.40 per share. Illustrative prices.

Premium received: $43,520
Premium as a share of position value: 4.35%
Value if called at $165: $1,165,520
Best case as a percentage gain: 16.40%
Appreciation forgone if the price reaches $190: $170,000
Downside cushion: 4.35%

The structure exchanged everything above a 16.40 percent gain for a 4.35 percent cushion, and handed the timing of a sale to someone else.

Check yourself

You hold 4,200 shares at $210 and write calls struck at $235 for $9.75 per share. What is the most the position can be worth at expiry, and what is that as a percentage gain?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.