The entire investment is lost for the option holder if the stock doesn't rise above the strike price. However, a call buyer's loss is capped at the initial investment.
No, a covered call will never lose money on the call part of the position. If the stock drops to below what you paid for the stock part minus what you got for the option part, the overall combination is a loser, but the option part reduced the overall loss by the premium.
The maximum loss of the call option buyer is the maximum profit of the call option seller. Likewise, the call option buyer has unlimited profit potential, mirroring this the call option seller has maximum loss potential.
The option seller is forced to buy the stock at a certain price. However, the lowest the stock can drop to is zero, so there is a floor to the losses. In the case of call options, there is no limit to how high a stock can climb, meaning that potential losses are limitless.
The Bottom Line
For a call option to by OTM, it will have a strike price that is above the current market level. An OTM put with have a strike price that is below the current market price. At expiration, if an option is out of the money, it will expire worthless.
But if the stock drops more than the premium received from selling the call option, the covered call strategy begins to lose money. In fact, the covered call's maximum possible loss is the price at which the stock was purchased minus the credit(s) from the short calls plus transaction fees.
Selling Call Options
If the option buyer exercises their own option profitably while the underlying security price increases over the option strike price, their profit will be diminished, and they may even lose money.
Can I sell an option below strike price? Options that have value in the marketplace can be bought or sold at any time, whether the underlying price of the stock is below or above the options strike price.
So, when you buy and sell options simultaneously, the time value that you lose in the bought option position will be offset by the gain in time value in the short option position. In this way, your losses can be minimized.
Like other securities including stocks, bonds and mutual funds, options carry no guarantees. Be aware that it's possible to lose the entire principal invested, and sometimes more. As an options holder, you risk the entire amount of the premium you pay.
There are three traditional ways of exiting an options position. Exercise the position, allow the position to expire worthless, or offset it. Most traders choose the later and reverse the order to close, just like they traditionally do with stocks. But you don't always have to go that route.
The estimated average salary for an options trader in the U.S. ranges from $65,000 to $185,000. However, retail traders using their own capital may earn more or less (or even lose money) depending on their trading proficiency and trading capital.
The most profitable option strategy varies based on market volatility and risk appetite. Strategies like selling covered calls or cash-secured puts can generate consistent income, while directional strategies such as long straddles or iron condors thrive in high volatility environments.
As a seller, you begin with a net credit because you collect the premium. If the option is never exercised, you keep the money. If the option is exercised, you still keep the premium but are obligated to buy or sell the underlying stock if assigned.
Selling naked options can also generate premium income, especially in volatile markets, but exposes traders to unlimited losses on naked calls or significant losses on naked puts if the market suddenly moves against them.
A stock occasionally pays a big dividend and exercising a call option to capture the dividend may be worthwhile. Or you may not be able to sell it at fair value if you own an option that's deep in the money. It may be preferable to exercise the option to buy or sell the stock if bids are too low.
By exercising a call early, you may be leaving money on the table in the form of time value left in the option's price. If there is any time value, the call will be trading for more than the amount it is in-the-money.
However, the call option expires worthless if the stock price is below the strike price at expiration. For example, using the December 2024 $45 call option from before, the option would be worth $5 per contract if the underlying stock finished expiration in December at $50, or $50 minus $45.
Sellers of covered call options are obligated to deliver shares to the purchaser if they decide to exercise the option. The maximum loss on a covered call strategy is limited to the price paid for the asset, minus the option premium received.
You will sell a call option that you own when you believe the price of the underlying stock is going to go down, or fear that its value is going to decrease over time due to time decay. On the other hand, you will short sell a call option if you expect the stock price to stay constant or decrease in value.
An option strategy has unlimited loss if it is net short call options or underlying. The theoretically unlimited loss occurs on the upside (when underlying price gets infinitely high). This list assumes underlying price can't be negative, which is the case with most underlying assets.
Risks of Covered Calls
Another risk of covered calls is the potential for loss if the stock price declines. The premium received from selling the call option provides some downside protection but may not fully offset losses if the stock price decreases a lot.
A married put is generally considered a bullish strategy with a protective stance. Investors use it when they are optimistic about the stock's long-term prospects but want to protect against short-term downside risk.
Keep in mind that the maximum loss possible when selling or writing a put is equal to the strike price minus the premium received. Suppose Company XYZ's stock is trading for $50, and you sell three-month puts with a strike price of $40 for a premium of $5.