What Is a Covered Call? Strategy, Payoff, Risk and Example
A practical guide to covered calls, including premium income, capped upside, downside risk and examples.
# What Is a Covered Call?
A covered call combines ownership of the underlying asset with selling a call option against that holding.
The investor receives premium but gives up upside above the call strike, while still carrying substantial downside risk in the underlying.
Example
Suppose an investor owns 1,000 shares at ₹1,000 and sells a ₹1,100 call for ₹30.
Premium received:
₹30 × 1,000 = ₹30,000
If the stock remains below ₹1,100 at expiry, the call may expire worthless and the investor keeps the premium, subject to applicable settlement rules.
If the stock reaches ₹1,200:
Combined gain = ₹130 per share, or ₹1,30,000 before costs.
Downside Risk
If the stock falls to ₹800:
Share loss = ₹200
Premium cushion = ₹30.
Approximate combined loss:
₹200 − ₹30 = ₹170 per share
The premium does not eliminate equity downside.
Payoff
| Stock at Expiry | Approx. Combined P&L/share |
|---:|---:|
| ₹800 | −₹170 |
| ₹1,000 | +₹30 |
| ₹1,100 | +₹130 |
| ₹1,200 | +₹130 |
Why Use a Covered Call?
It may be considered when an investor holds the underlying and expects limited upside over the option period.
The central trade-off is:
Premium income ↔ capped upside
Covered Call vs Naked Call
A covered call holds the underlying asset. A naked short call does not.
The covered position still has significant downside because the shares can fall.
Key Risks
Key Takeaways
FAQs
Is a covered call risk-free?
No.
Does it guarantee income?
No. Premium is received, but the overall position can lose value.
What is the main trade-off?
Premium income versus limited upside.
Final Thoughts
A covered call is a useful structure for understanding how option premium can be exchanged for giving up part of future upside.
Related reading: What Is Option Premium? · Option Buyer vs Seller
> Disclaimer: Educational only; not financial advice. Options involve substantial risk.
This article is for educational purposes only and does not constitute financial advice. Please consult a SEBI registered investment advisor before making any investment decisions.