What Are The Maximum Profit-Loss Outcomes Of Covered Calls?

Jesse Anderson

Published on September 24, 2021

Covered calls are proven options strategies employed by both short-term and long-term investors. Writing covered calls on long stock positions can hedge your portfolio risk while boosting the income from your portfolio. Although selling covered calls for income can offer some risk reduction, the potential for maximum gains and losses is limited. When you are finding the best stocks to sell covered calls, it’s very important to keep some vital points in consideration.

Let’s get started with learning all the possible outcomes of selling covered calls for monthly income before you start trading.

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Best Stocks to Sell Covered Calls – Visualizing All Possible Outcomes Of Selling Covered Calls

When you sell covered calls, you must deliver the purchased shares at the predetermined strike rate if the buyer exercises their right to acquire before the expiration date. As the stock owner, you get to keep the premium amount irrespective of the buyer’s decisions.

Possible outcomes of selling covered call options can be studied as a profit-loss diagram for the underlying stock. With the profit-loss graph, you can easily follow how stock prices impact the covered calls’ profit to determine the three possible outcomes of selling covered calls; the maximum profit, the maximum loss, and the break-even point.

Calculating Maximum Covered Calls Profit

Before using covered calls for income, you should know that the maximum profit you can generate from selling covered calls has a ceiling. Since you agreed to sell your shares at a predetermined price, your upside will be limited by the strike price plus the option premium, even if the stock price quadruples.

Once your shares exceed the strike price of your covered call, you’ve reached maximum profit.  You will not benefit from any additional appreciation.  

Maximum Covered Calls Profit Formula:

Maximum (Per Share) Profit = (Strike Price – Stock Purchase Price) + Covered Call Options Premium

Calculating Maximum Loss On Writing Covered Calls

Selling covered calls for monthly income offers built-in downside to partially reduce the risk of losses if your stock declines in price. Even if the stock prices pummeled down to zero by some tragedy, you will lose all the capital you invested in the stock but are still entitled to keep the premium amount you received when you sold the covered call.

The maximum loss on selling covered calls is defined by what you paid for purchasing the stock minus the premium amount received for selling the covered call options.

Maximum Covered Calls Loss Formula:

Maximum (Per Share) Loss = Stock Entry Price – Covered Call Options Premium

Determining The Break-Even Point For Covered Call Stocks

The break-even point for covered call options is achieved when the market price of your stock declines by the premium you collected selling the calls.  Simply stated, your call premium offsets the price decline of the stock and you can break even on the covered call position even when stock prices decline.

For any investor, the break-even point offers a chance to safely exit their long positions on owned stocks at zero covered calls profit and loss.  Keep in mind, you’ll have to buy to close the option before the sale of your shares to fully exit the entire position.  

Break-Even Point Formula:

Break-Even Point = Stock Purchase Price – Covered Calls Options Premium

Selling Covered Calls For Income – PROS

Regular Income Generation

You can generate a steady cash flow by selling covered calls for monthly income against long-positioned stocks you own. Investors use covered calls profit strategies to grow their future retirement funds or boost their income in retirement.

Stock Position Exiting

If you are ready to sell a stock position but aren’t ready to do so immediately, you can use the various covered call options to exit your current stock position. You can sell calls at an acceptable strike price where you are comfortable selling your shares.  , As you sell covered calls, you earn a premium and collect covered calls profit.  You can continue to sell covered calls month after month until your shares exceed the strike price at expiration.  

Downside Risk Hedging

Another reason for selling covered calls is to reduce your risk and hedge your potential losses. The premium amount you receive by selling covered calls can help offset your downside during market declines and doubles up as extra cash income if the market is stable.

Selling Covered Calls For Income – CONS

Stock Price Appreciation

Selling covered calls limit your upside when the stock price goes beyond the strike price. Even if the asset price soars, you are obligated to sell your stock at the fixed strike price.

Stock Price Depreciation

When you are looking for the best stocks to do covered calls, you’re on the hook for the downside if the asset value declines. You may offset some losses with the covered call option premium, but you can still end up in the red overall if the price declines significantly.

Covered calls are a neutral-to-bullish trading strategy that works best with maintained or slightly increasing stock values. Selling covered calls for income, exiting market positions, or reducing losses are all common reasons investors choose to utilize covered call options. 

Are you thinking of the best stocks to sell covered calls for monthly income but can’t find the best stocks for covered calls? optionDash is the best-covered call stock screener available for new and seasoned investors.