Covered Call Examples

As a continuation of the covered call basics page, let's explore some covered call examples.

XYZ Zipper Company - Covered Call Examples

Let's assume that the XYZ Zipper Company is trading at $33.50/share. Although the stock has shown a fair degree of volatility in the past, you feel that it's fairly valued and you don't expect it to move much higher anytime soon.

You're also planning a vacation to somewhere special like the Cadillac Ranch, Dollywood, or that big-ass statue of Paul Bunyan in Bangor, Maine, and you wouldn't mind generating some extra cash for the trip.

Here are the moving parts:

• You already own 100 shares of XYZ (and let's assume you purchased it at its current value), and you decide to sell a $35 call option that expires in one month.
• The bid on the call option is $1. That means, excluding commissions (in the Land of Examples it's always sunny), you pocket an even $100.
• As long as the stock stays below $35/share, the premium received is yours free and clear, and the underlying stock remains in your possession.

Covered Call Scenarios

Based on the call writing example above, here are some other possible outcomes:

• The FDA unexpectedly approves The XYZ Zipper Company's controversial Medical Zipper device for general surgical use and the stock jumps to $45/share. - The good news is that you're not going to lose any money. The bad news is that you miss out on all the capital gains above $35/share. The premium is yours to keep as well as all profits up to $35/share. Your net gain per share then is $2.50/share ($35/share price less the original purchase price of $33.50/share plus the $1 call option premium received when you sold the covered call).
• As you anticipated, the stock goes nowhere and closes at expiration at $33.50/share - Well played. Buy and hold got you nowhere, so you look pretty smart selling the covered call. Depending on how you prefer to calculate it, you either gave yourself an approximate 3% special dividend or you lowered your cost basis in the position by a buck.
• The CEO of The XYZ Zipper Company is arrested on drug, prostitution, and weapons charges and the stock plummets to $13/share - Whoops. You really wish now that you'd invested in a conservative button manufacturer like your hair stylist advised you to. The only positive development is that $100 premium you received from writing the covered call - that's yours to keep.