What is a Covered Call? Definition, Formula, and Example
A covered call is an options strategy where you sell one call option against 100 shares you already own, collecting premium in exchange for capping your upside at the strike price.
What is a Covered Call?
A covered call is a two-legged position: you own 100 shares of stock (the "cover") and simultaneously sell one call option against them. The buyer of that call pays you a premium upfront. In return, you agree to sell your shares at the strike price if the stock closes above it at expiration. The strategy converts a pure equity position into a yield-generating one — at the cost of forfeiting gains above the strike.
How a Covered Call is Structured
The payoff math is fixed:
Max Profit = (Strike − Purchase Price) + Premium Collected
Breakeven = Purchase Price − Premium Collected
Max Loss = Purchase Price − Premium Collected (stock going to zero, offset only by the premium)
The position has identical risk to the downside as owning stock outright — the premium cushions the fall but doesn't eliminate it. Above the strike at expiration, the shares are called away at the strike price and you miss every dollar of upside beyond that point.
Worked Example: AAPL
Own 100 shares of AAPL purchased at $195.00. Sell the $200 call expiring 30 days out for $3.20 per share ($320 total premium).
| Scenario at Expiration | P&L |
|---|---|
| AAPL at $180 (down 7.7%) | −$1,180 (−$1,500 stock loss + $320 premium) |
| AAPL at $191.80 (breakeven) | $0 |
| AAPL at $195 (flat) | +$320 (premium only) |
| AAPL at $200 (at strike) | +$820 (max profit) |
| AAPL at $215 (surges) | +$820 (capped — miss $1,500 of upside) |
The $3.20 premium represents a 1.6% yield on the $195 position in 30 days. Annualized if repeated: ~20%.
When Traders Use a Covered Call
Covered calls suit three situations. First, income on a hold: selling monthly calls on a core position generates yield while waiting for a longer-term thesis to play out. Second, cost basis reduction: repeatedly collecting premium lowers the effective cost of the shares over time. Third, managed exit: selling a call at your target exit price turns the position into a limit sell with built-in income — you either collect premium or get filled at your desired price.
Limitations and Misconceptions
The strategy doesn't protect against large drops. A stock falling 30% is a 30% loss minus a small premium buffer. Covered calls are not "free money" — you are selling a right that has value, and you pay for it via capped upside. Tax consequences matter: if the call is exercised and shares are called away, it may reset a long-term holding period to short-term depending on the strike and timing, creating an unexpected tax event. Finally, selling calls before earnings to collect elevated implied volatility is tempting but carries the highest assignment and gap risk — a post-earnings rally can blow through the strike dramatically.