Covered call consists of two positions at the same time. One is Long position on the underlying asset (suppose we bought an asset at S0 = USD 70) and short a call option (suppose at X= USD 100). Here strike price of the call option should be higher than the buying price of the underlying asset.
Premium received for selling the call option = USD 5
Maximum Profit is fixed from this derivative instrument. Maximum profit = X + Premium Received – Buying Stock price = USD (100+5-70) = USD 35
Profit stays same for any share price higher than strike price that is USD 100.
Maximum Loss happens when the stock price touches 0. At that time, loss from underlying stock becomes USD 70 and due to receipt of premium total loss stood at USD 65 (70-5).
Breakeven price is the share price where the profit stood at 0 and it separates profit from loss. Here the breakeven price would be USD (70-5) = USD 65. For any share price lower than USD 65, the trader will make loss and for any share price higher than USD 65, the trader will gain profit.
The following table shows the profit/loss scenarios for different share prices.
The below chart shows the profit/loss for covered call option with the movement of the share price.
Here we have three graphs
Covered call trading strategy is used to generate additional profit when the trader/investor is sure that the underlying share will remain unchanged over the short span of time. He aims to generate profit from narrow range movement of the share price. Normally, the buying underlying share price (S0) remains much low compared to the strike price which increases the maximum profit and reduces the potential loss out of this trading strategy.