Covered Call

A covered call is a call sold against a long futures position; that is, the writer of the call takes on a potential obligation to provide a futures contract at a specific price, and tries to mitigate his risk by simultaneously buying futures. The premium is collected up front at the initiation of the position. Income is earned if futures hold stable to slightly higher or lower, allowing the writer of the call to retain the options premium. The position is helped by lower volatility and the passage of time, all of which make it unlikely that the options contract will be exercised.

Profits are limited to the premium received plus some appreciation in the futures position. Losses are potentially unlimited. The premium received from the sale of the call acts as a partial hedge against the futures position as prices decline.

Position Premium Dollar Premium Delta Buy one $20 crude oil futures +1.00 Sell one $22 call - Net credit - Net delta $0.50 $0.50 $500 $500 -.29 +.71 Maximum risk unlimited Maximum profit $2.50 per barrel $2,500 per covered call Break-even futures price $19.50 Position Premium Dollar Premium Delta Buy one $260 crude oil futures +1.00 Sell one $270 call - Net credit - Net delta $3.00 $3.00 $300 $300 -.30 +.70 Maximum risk unlimited Maximum profit $13.00 per oz. $1,300 per contract Break-even futures price $257