Visualizing Covered Calls
For an introduction to covered calls, read the Wealthsimple article: What is a covered call?
The graph on this page serves two purposes: it conveys how a covered call P/L can differ from simply holding a stock over the same time period, and how different strike prices affect the break-even price and potential opportunity loss if the stock rallies.
A hypothetical example:
100 Shares of $AAPL are acquired for a purchase price of $100. Given the current price, and $AAPL's 'greeks', a trading platform is offering the following premiums for contracts with the corresponding strike prices. The contracts have a 7 day expiry.
Premium: $2.50/share ($250.00 Total)
Selling A Contract
The contract is sold with $AAPL currently at $100.
The P/L immediately increases by $250.00. Click next to see four potential outcomes at the time of expiry.
Scenario 1
The contract expires with $AAPL at $97.50.
The stock price has dropped, however it's been offset by the premium collected. This is the break-even price.
Scenario 2
The contract expires with $AAPL at $105.00.
The shares are re-assigned at the strike price, locking in a P/L of $7.50 per share. Net outcome = a profit of $750.
Scenario 3
The contract expires with $AAPL at $107.50.
Any further price increase is an opportunity loss equal to the divergence between the two lines.
Scenario 4
The contract expires with $AAPL at $114.00.
Stock-only P/L continues rising, while the Covered Call P/L stays capped at the strike price.