Generate Income: The major reason to write a covered call is to collect the premium from selling the call option, which provides additional income.

Hedge Slightly: If the stock falls slightly, the premium received from the call option can offset some of the loss on the stock.

Cap Gains: While the investor profits from the stock's appreciation, this gain is limited to the strike price of the call option. If the stock price rises above the strike price, the investor must sell the stock at the strike price.

 

An Illustration Using Apple Stock (AAPL)

Suppose an investor own 100 shares of Apple (APPL) stock, and its currently trading at $180 per share. The inspector expects the stock price to remain relatively stable or rise modestly, so you decide to sell a covered call.

•  Stock Ownership: The investor own 100 shares of Apple , valued at $180 per share, for a total of $18,000.

• Sell a 190 Strike Call: The investor sells a call option with a strike price of $190, expiring in 30 days, and collect a premium of $3 per share, for a total of $300.

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Key Transaction Notes:

• Premium Collected: $300 (from selling the 190 strike call).

• Maximum Profit: If Apple's stock rises to or above $190, you'll make a profit on the stock plus the premium collected. The max profit occurs when the stock is at $190 or higher.

Maximum Profit = ($190 - $180) * 100 (from stock appreciation) + $300 (premium) = $1300.

• Breakeven Point: The breakeven point is the price at which the combined position (stock and call) neither makes nor losses money. Breakeven Point = $180 (stock price) - $3 (premium collected) = $177.

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Possible Outcome Scenarios:

1. Stock Price stays Below $190 at Expiration: This is ideal if the investor wants to hold the stock and generate income from selling options. The call option expires worthless, the investor keeps the premium ($300), and you still own the 100 shares of Apple. If the stock price stays between $177 and $190, the investor can sell another covered call for additional income.

2. Stock Price Exceeds $190 at Expiration: If Apple's stock price goes above $190, the call option will be exercised, and the investor must sell his shares at the strike price of $190. The investor lose out on any additional upside above $190, but will still make the maximum profit of $1300 (stock appreciation + premium collected).

3. Stock Price Drops Below $177: If Apple's stock falls below $177, the premium collected will only partially offset the decline in the stock's value. The investor's overall position would start to lose money below this price.

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Pros of a Covered Call:

• Slight Downside Protection: The premium collected from selling the call provides a small cushion against losses if the stock price falls.

• Enhanced Returns: In a flat or mildly bullish market, the investor can boost his returns from the stock by consistently selling call options.

• Income Generation: Selling call options provides extra income, especially useful in a sideways or slightly bullish market.

 

Cons of a Covered Call:​

• Limited Upside Potential: If the stock price rises significantly above the strike price, the investor's upside is capped since he must sell the stock at the strike price.

• Potential for Stock Losses: The premium from selling the call provides limited protection if the stock price declines sharply.

• Opportunity Cost: If the stock price surges past the strike price, the investor misses out on further gains, as the investor you must sell the stock at the strike price.

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In Conclusion

A covered Call is a strategy that allows investors to generate income by selling call options on stocks they already own. The goal is to collect the premium from the call option, which provides income while accepting limited upside. Using Apple stock as an example, the investor can generate $300 by selling a covered call while capping your profit if the stock rises above the call's strike price of $190. This strategy is ideal for neutral to slightly bullish outlooks but carries the risk of missing out on larger gains if the stock price rises sharply.

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