Stop Calling the Covered Call an Income Strategy. Here Is What It Really Does.

General Motors

The covered call strategy on General Motors involves selling a short out-of-the-money call with a 32-day expiration. The goal is to reduce the cost basis of the long stock position. If the stock price reaches $80, the call will be assigned, and the stock can be sold at a higher price, resulting in a 5% return on the long stock. The strategy is valid if the stock price does not fall below $75.88 within the 32-day period. The trade is considered successful if the stock price reaches the target strike price, allowing for a profit from the reduced cost basis.

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The covered call strategy involves selling call options to reduce the cost basis of a long stock position. The trader must choose a strike price that balances the desired cost basis reduction against the potential profit if the stock price rises above the short strike price. The choice of strike price depends on the trader's outlook for the stock and the volatility of the options market.

Covered Call Strategy as a Cost Basis Reduction Tool

A covered call strategy involves holding a long stock position and selling a short out-of-the-money call. This approach is primarily used to reduce the cost basis of the long stock, thereby lowering the risk and increasing potential profit. The reduction in cost basis means the net price paid for the stock is lower, which can result in a higher potential profit if the stock is sold at a later date. This strategy is particularly useful for traders looking to generate income while holding a stock position.

Cost Basis Reduction Through Covered Calls

Selling covered calls can reduce the cost basis of a long stock position by a percentage determined by the ratio of the call premium to the stock price. This reduction is calculated by dividing the call price by the stock price, which provides a percentage reduction in cost basis. The choice of strike price affects the reduction amount, with options further out of the money typically offering a smaller reduction. The trader must balance the desired cost basis reduction against the potential profit if the stock price rises above the short strike price.

What is a covered call?

A covered call is a strategy that involves holding a long stock position and selling a short out-of-the-money call. This strategy is used to reduce the cost basis of the long stock, thereby lowering the risk and increasing potential profit.

TakeawayA covered call is a strategy that reduces the cost basis of a long stock position by selling a short out-of-the-money call.

How does selling a short call affect the cost basis of a long stock position?

Selling a short call reduces the cost basis of a long stock position by the ratio of the call premium to the stock price. This reduction is calculated by dividing the call price by the stock price, which provides a percentage reduction in cost basis.

TakeawayTraders can use the ratio of the call premium to the stock price to determine the percentage reduction in cost basis when selling a short call.