Let’s create an example using Wal-Mart Stores, Inc. (WMT) by going long 100 shares of WMT @ 71 ½ and short 1 January WMT 80 Call @ 4 ¼. The maximum profit for this trade is the premium received for the short call option plus the profit to be gained on the long stock. The maximum reward on the option side of this position is $425 (4 ¼ x 100 = $425). The maximum reward on the stock side of this position is $850 [(80 – 71 ½) x 100 = $850]. The total profit on this particular covered call strategy is $1,275 (425 + 850 = $1,275). The maximum risk is limited to the downside as Wal-Mart drops in price beyond the breakeven all the way to zero. The option side of this trade does not require a margin deposit to place because the short call option is already covered by the long stock.
The breakeven on a covered call is calculated by subtracting the call option premium from the price of the underlying stock at initiation. In this example, the breakeven is 67 ¼ (71 ½ – 4 ¼ = 67 ¼). Wal-Mart must drop below 67 ¼ for the trade to begin to take a loss (not including commission costs). The maximum profit of $1,275 will be received if the stock rises to or above 80 and the call is exercised.
On December 24, Wal-Mart climbs above $80 per share. If the short 80 call is exercised, 100 shares of Wal-Mart will be sold to permit delivery to the assigned option holder. The $425 credit from the option and the additional profit from the sale of the Wal-Mart shares bring the total profit on the trade to $1,275.
Long 100 shares WMT @ 71 ½, Short 1 January WMT 80 Call @ 4 ¼
Debit at Initiation Stock Price at Exit Days in Trade Profit / Loss
$7,150 – $425 = $6,725 80 22 $1,275