CFA CFA Level 1 Options (Derivatives) – covered call

Options (Derivatives) – covered call

  • This topic has 1 reply, 2 voices, and was last updated Dec-17 by artyeasel.
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    • sharz
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      Can someone please explain the meaning/significance of a covered call, how to determine pay off , max profit/loss , and anything in relation to this concept .
      thank you

    • artyeasel
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      @sharz

      A covered call is when you sell a call option (right to buy) on an asset you already own. Usually this is when you’re expecting the price of the asset to trade flat or slightly lower, and you’re looking to make money from the premiums of the call options you’re selling (you’re betting it won’t exercise).

      For example, say you hold x Apple shares (price: $101.60). You then sell an equivalent number of call options at a strike price of $110, earning you a premium. 3 scenarios can happen:

      1. APPL trends flat (remains at $101.60). You don’t make money from your APPL shares (asset), but you get to keep your premium (from selling call options), so you profit.
      2. APPL shares drop (below $101.60). You lose money from your APPL shares (asset), but you get to keep your premium (from selling call options). Final profit/loss depends on how much you lose from your asset, and how much you gained from premiums.
      3. APPL shares rise (above strike price of $110). You make money from your APPL shares (asset), but only up to $110, as profit beyond that is counteracted by the call option (you have to pay the option buyer the difference). Thus you still profit, but less than if you’ve just held your APPL shares without selling the call options.

      So maximum profit is when price of asset = strike price of call options.

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