What Is a Covered Call Strategy?

Short answer: A covered call is when you own the underlying shares and sell a call option against them to earn premium income, accepting that you may have to sell the shares if the price rises above the strike.

How It Works

You hold shares of a company (in the required lot quantity) and sell a call option on them. You receive the premium immediately. If the stock stays below the strike at expiry, the call expires worthless and you keep both the shares and the premium. If it rises above the strike, you may have to deliver the shares at the strike price.

Why Investors Use It

The main goal is to generate extra income on shares you already own and plan to hold, especially when you expect the price to stay flat or rise only modestly. The premium provides a small cushion against minor declines and a steady income stream in sideways markets.

The Trade-Off

The cost of this income is capped upside. If the stock surges well above the strike, you miss those extra gains because you are obligated to sell at the strike. You keep the premium, but you forgo the larger rally. This is acceptable if you were content to sell at that level anyway.

Managing the Risk

The strategy is "covered" because you own the shares, so unlike a naked call, your risk is not unlimited. Your real risk is that the stock falls, in which case you still bear the loss on the shares, partly offset by the premium received.

Choosing the Strike

A strike close to the current price earns more premium but caps upside sooner and raises the chance of having to sell. A strike further out earns less premium but lets you keep more upside. The choice reflects how bullish you are.

Practical Notes

Covered calls suit investors comfortable with possibly selling their shares at the chosen strike. In India, remember that stock options may involve physical delivery on expiry, so plan for assignment. Used sensibly, it is a relatively conservative way to enhance returns on existing holdings.

This explainer was written by The Dispatch desk to answer a question readers commonly ask. It is general information, not personalised financial advice.