Covered calls, explained like you're five
A covered call is when you sell someone the right to buy 100 shares you already own, at a set price, before a set date — and they pay you cash today for that right. You keep the cash whatever happens. In exchange you give up any gain above that price.
Kovered.ai is for sale — make an offer
You own shares. Someone pays you cash today for the right to buy them from you later at a price you both agree on now. That's the whole idea. Everything else is detail.
What is a covered call?
Imagine you own a house you're happy to keep. A neighbour says: here's £200 today. In exchange, if I decide to buy your house in the next month, you have to sell it to me for £300,000.
You take the £200. Three things can happen:
- Your neighbour never buys. You keep the house and the £200.
- The house is worth £290,000 at the end of the month. They don't buy — why pay £300,000? You keep the house and the £200.
- The house jumps to £340,000. They buy at £300,000. You keep the £200, but you sold for £300,000 something now worth £340,000.
A covered call is that trade, with 100 shares instead of a house. The £200 is the premium. The £300,000 is the strike price. The month is the expiration.
Why is it called a “covered” call?
Because you already own the shares you've promised to deliver. Your obligation is covered by something you actually hold.
The word does similar work elsewhere: in health cover, “covered” also means considered, not free.
Sell that same promise without owning the shares and it's a naked call. If the price rockets, you have to go buy at the market price to deliver at the strike, and there's no ceiling on what that costs you. Same contract, completely different risk. The word "covered" is doing real work.
Covered call example, with the actual numbers
Say you own 100 shares trading at $50, so $5,000 of stock. You sell one call: strike $55, expiring in 30 days, premium $1.50 per share. One contract is 100 shares, so you collect $150 immediately. That cash is yours whatever happens next.
| Price at expiry | What happens | Your position |
|---|---|---|
| $45 | Call expires worthless | Shares worth $4,500 + $150 premium. Down $350 instead of $500. |
| $50 | Call expires worthless | Shares worth $5,000 + $150. Up $150 on a flat stock. |
| $55 | Right at the strike | $5,500 + $150. Best case: full gain and the premium. |
| $65 | Shares called away at $55 | $5,500 + $150 = $5,650. You'd have had $6,500 holding. |
Read the last row carefully, because it's the whole trade-off. You made money. You also made $850 less than doing nothing.
Covered call pros and cons
You get: cash today, regardless of what the stock does. It arrives when you sell, not at expiry.
You give up: everything above the strike. Your upside is capped at strike plus premium, permanently, for the life of the contract.
You do not get: meaningful downside protection. If the stock halves, the premium covers a sliver of that. A covered call is not a hedge. It converts uncertain upside into certain, small income.
That makes it a reasonable fit for shares you're content to hold and content to sell at the strike. It's a poor fit for a position you're convinced is about to run.
Common covered call mistakes
- Assignment can come early. American-style options can be exercised any time before expiry, not just at the end. It's most likely just before an ex-dividend date, when exercising early captures the dividend.
- Fat premiums are a warning, not a gift. Premium scales with implied volatility. An unusually rich premium is the market pricing in an unusually large move — often an earnings date sitting inside your contract.
- Selling below your cost basis locks in a loss. If you paid $60 and sell a $55 call, getting assigned means realising a loss no premium is likely to cover.
- Tax treatment is not neutral. Premiums and assignments are taxable events, and in some jurisdictions certain covered calls can affect the holding period of the underlying shares. Worth checking before you build a routine around it.
Covered call FAQs
Can I lose money on a covered call?
Yes — from the shares. The premium is yours to keep, but it only offsets a small part of a large drop. Your loss is the same as holding the stock, reduced by the premium.
What happens if the stock goes up a lot?
Your shares are sold at the strike price. You keep the premium plus the gain up to the strike, and forgo everything above it.
Do I need 100 shares?
For a standard contract, yes — one contract covers 100 shares. Some markets list smaller contracts, but 100 is the norm.
Is a covered call safer than owning the stock?
Slightly less risky, in that the premium cushions a fall. But the downside is essentially unchanged while the upside is capped, so it is not a defensive strategy.