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.
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.
Risk Level: Selling a put generally carries more risk because the potential loss can be significant, especially if the underlying asset's price falls dramatically. Conversely, buying a call has a defined risk (the premium paid) and unlimited profit potential.
Potential to outperform the market: In a flat or slightly bullish market, selling covered calls can potentially outperform a buy-and-hold strategy on the underlying stock, as the investor collects premiums while the stock price remains steady or rises slightly.
Limited Upside Potential
The biggest downside to selling covered calls actually isn't a risk in the sense that you could face losses – it's opportunity cost. Call options are binding contracts that require you to sell your shares at a predetermined price should the buyer choose.
You usually wouldn't want to sell covered calls when the market is very undervalued, for example. Covered calls are a useful tool, and in the hands of a smart investor in the right circumstances, can be tremendously profitable.
If you think the market price of the underlying stock will rise, you can consider buying a call option compared to buying the stock outright. If you think the market price of the underlying stock will stay flat, trade sideways, or go down, you can consider selling or “writing” a call option.
Selling a call option is a bearish position. Ideally, traders who sell calls want the underlying's price to drop and for the option to expire OTM. Short call positions can also be bought to possibly lock in a certain profit or loss before expiration.
Puts (options to sell at a set price) generally command higher prices than calls (options to buy at a set price). One driver of the difference in price results from volatility skew, the difference between implied volatility for out-of-the-money, in-the-money, and at-the-money options.
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.
The covered call strategy requires two steps. First, you already own the stock. It needn't be in 100 share blocks, but it will need to be at least 100 shares. You will then sell, or write, one call option for each multiple of 100 shares: 100 shares = 1 call or 200 shares = 2 calls.
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.
As options approach their expiration date, they lose value due to time decay (theta). The closer an option is to expiration, the faster its time value erodes. If the underlying asset's price doesn't move in the desired direction quickly enough, options buyers can suffer losses as the time value diminishes.
A naked call option is when an option seller sells a call option without owning the underlying stock. Naked short selling of options is considered very risky since there is no limit to how high a stock's price can go and the option seller is not “covered” against potential losses by owning the underlying stock.
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.
A covered call is better for longer term positions or collect a dividend, while selling puts is a good way to hold cash as a shorter term position. Cash-secured puts can only result in profit from the option premium, while covered calls have potential profits from both option premiums and stock dividends/appreciation.
If your long option is ITM at expiration but your account doesn't have enough money to support the resulting long or short stock position, your broker may, at its discretion, issue a do not exercise (DNE) on your behalf, and any gain you may have realized by exercising the option will be wiped out.
The risks in selling uncovered calls and puts
This strategy is considered very high risk, as you're theoretically exposed to unlimited losses. That's because there's really no limit to how high a stock can rise.
A covered call is an options trading strategy that involves an investor holding a long position in an underlying asset, such as a stock, while simultaneously writing (selling) call options on the same asset. This approach aims to generate additional income from the premiums received by selling the call options.
A call option gives a trader the right to buy the asset, while a put option gives traders the right to sell the underlying asset. Traders would sell a put option if they are bullish on the asset's price and sell a call option if they are bearish on the price.
Selling covered calls is a strategy that can help traders potentially make money if the stock price doesn't move. Learn how this strategy works. The covered call is one of the most straightforward and widely used options strategies for investors who want to pursue an income goal to potentially enhance returns.
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.
Options contracts allow buyers to gain exposure to a stock for a relatively small price. They can provide substantial gains if a stock rises, but can also result in a total loss of the premium if the call option expires worthless due to the underlying stock price failing to move above the strike price.