The basic concept of covered call writing is very simple. However, for the investor who is unfamiliar with this process it can be confusing at first. At this time we would like to reiterate the concept now that you are more familiar with it.
WRITING A COVERED CALL CONSISTS OF THE SALE OF AN OPTION CALL WHILE SIMULTANEOUSLY OWNING THE UNDERLYING STOCK.
Below is a chart showing different covered call transactions:
| EXAMPLE STOCK | STOCK PRICE | OPTION PRICE | STRIKE PRICE | RETURN IF NOT CALLED | RETURN IF CALLED |
| 1 - ABC | 25 | 2.5 | 25 | 10.00% | 10.00% |
| 2 - DEF | 24 | 2 | 25 | 8.33% | 12.50% |
| 3 - GHI | 26 | 3 | 25 | 11.54% | 7.69% |
| 4 - JKL | 50 | 4 | 50 | 8.00% | 8.00% |
| 5 - MNO | 48 | 3.5 | 50 | 7.29% | 11.46% |
| 6 - PQR | 52 | 6 | 50 | 11.54% | 7.69% |
In Example 1 we bought 100 shares of ABC for $25 a share, for a total of $2500 (100 x $25). Then, we sold the $25 call for $2.5 a share, for a total of $250 (100 x $2.5). If the stock price stays at $25 or higher we will be "called out" and make $250.
IMPORTANT: Selling a call means that you have agreed to sell someone YOUR shares of a stock at a particular price. If the stock price on the strike date (third Friday of each month) is greater than the strike price, you will sell your shares. This whole process is handled automatically by both full service and online brokers.
In Example 2 we bought 100 shares of DEF for $24 a share, for a total of $2400 (100 x $24). Then, we sold the $25 call for $2 a share, for a total of $200 (100 x $2). If the stock price stays at $25 or higher we will be "called out" and make $300. Note here that we sold the stock for more than what we paid for it, therefore we made an extra $100 on the transaction ((25-24) x 100).
In Example 3 we bought 100 shares of GHI for $26 a share, for a total of $2600 (100 x $26). Then, we sold the $25 call for $3 a share, for a total of $300 (100 x $3). If the stock price stays at $25 or higher we will be "called out." Note here that we sold the stock for less than what we paid for it, therefore we "lose" $100 on the sale of the stock and profit $200 on the overall transaction.
In Example 4 we bought 100 shares of JKL for $50 a share for a total of $5000 (100 x $50). Then, we sold the $50 call for $4 a share, for a total of $400 (100 x $4). If the stock price stays at $50 or higher we will be "called out" and make $400.
In Example 5 we bought 100 shares of MNO for $48 a share, for a total of $4800 (100 x $48). Then, we sold the $50 call for $3.5 a share, for a total of $350 (100 x $3.5). If the stock price stays at $50 or higher we will be "called out" and make $550. Note here that we sold the stock for more than what we paid for it, therefore we made an extra $200 on the transaction ((50-48) x 100).
In Example 6 we bought 100 shares of PQR for $52 a share, for a total of $5200 (100 x $52). Then, we sold the $50 call for $6 a share, for a total of $600 (100 x $6). If the stock price stays at $50 or higher we will be "called out." Note here that we sold the stock for less than what we paid for it, therefore we "lose" $200 on the sale of the stock and profit $400 on the overall transaction.
If you are still confused, don't worry, keep reading.
