Covered Call Strategy Explained With Example

One of the biggest challenges that futures and options traders face is finding a strategy that helps them earn better and reduce losses. While this may sound a bit surprising, this is one of the reasons why beginners usually avoid trading in this segment. 

At the same time, if you are a trader who is looking to earn a stable return from this, it can be a bit hard. This is where you need to use the covered call strategy. This is a simple plan where you hold the stocks and earn a steady income from them.

Sounds amazing, right? Well, if you are looking to explore the same in detail, then read this guide. Explore everything you about the covered call option strategy with examples.

What Is a Covered Call Strategy?

A covered call strategy is an options trading strategy. It is the one where you sell a call option on a stock that you already own. This means you hold the shares and write a call at a chosen strike price. 

The income you earn comes from the option premium. This strategy is very common. It is mainly used by the traders when they expect the stock to stay flat or rise only slightly. Since you already hold the shares, the risk is limited. And now, at the same time, the premium offers a steady return for the short term.

Features of the Covered Call Strategy

A covered call works on a simple idea. You hold the stock and sell a call option on it. This creates a steady income with limited risk. Its features are:

• Must own the shares before selling the call.

• Getoption premium as fixed income.

• Stay protected from unlimited loss due to stocks.

• Best in a flat or mildly rising market.

• Lowers your overall holding cost and improves returns.

Pros and Cons of Covered Call Strategy

This strategy can add stability to your portfolio, but it also sets a limit on how much you can earn. A balanced view helps you decide when to use it. So, it is important that you know all the pros and cons before implementing this strategy. 

Pros

• Offers regular income through option premiums.

• Softens the impact of small price drops.

• Simple structure that beginners can use.

• Works well for long-term stockholders seeking extra income.

Cons

• Limits your profits if the stock rises above the strike.

• Shares may be taken away if the option is exercised.

• Not suitable when you expect a strong upward movement in price.

How the Covered Call Strategy Works

A covered call is built in a clear sequence. You hold the stock, sell a call option, and earn a premium for taking on the obligation to sell your shares at a fixed price. The steps followed are:

Step 1: Buy and Hold the Stock

You need to cover first. So buy the stocks and shares now. This will be your cover when you sell the option.

Step 2: Set a Strike Price and Expiry

Select a strike price that is above the current market price. Set the expiry date as per the goal and outlook.

Step 3: Sell the Call Option

You write the call option at the chosen strike. The buyer pays you a premium. This amount is your immediate income.

Step 4: Wait Until Expiry

If the stock stays below the strike, the call expires worthless, and you keep the premium. Your shares remain with you.

Step 5: Deliver Shares if Assigned

If the stock moves above the strike, the buyer may exercise the option. You must sell your shares at the strike price. You still keep the premium.

Step 6: Repeat the Strategy

Many traders use covered calls each month to earn consistent premium income. The process can be repeated as long as you hold the stock.

Covered Call Strategy Example

Sya, you have 100 shares of a stock that trades at Rs. 500. You decide to sell a call option with a strike price of Rs. 520. The premium you receive is Rs. 12 per share.

If the stock stays below Rs. 520

The call expires worthless. You keep the Rs. 12 premium and still hold your 100 shares. This becomes your steady income.

If the stock moves above Rs. 520

The option buyer may exercise the contract. You must sell your shares at Rs. 520. Your profit with the premium can be Rs. 500 to Rs. 520.

What this means

You earn income in both cases, but your maximum profit ends at the strike price. This is why the covered call strategy works best in a stable or slightly rising market.

Conclusion

A covered call strategy gives you steady income. At the same time, it helps to keep risk low. You earn premium and maintain your position as well. This is perfect for beginners and the experienced alike. And if you want to learn more option strategies or start trading with clarity, open your Rupeezy account today and explore tools that help you trade with confidence and better control.

FAQs

What is a covered call strategy in simple words?

It is a strategy where you hold a stock and sell a call option on it to earn premium income while limiting your upside profit.

Is a covered call strategy safe for beginners?

Yes, it is one of the safer option strategies because you already own the shares and your risk is limited.

When should I use a covered call strategy?

Use it when you expect the stock to stay flat or rise slightly and want to earn steady premiums.

Can I lose money in a covered call strategy?

You face loss only if the stock falls sharply. The premium helps reduce the impact but cannot remove the risk fully.

What happens if the stock crosses the strike price?

Your shares may be assigned and sold at the strike price. You still keep the premium, but your gains stop at that level.