Covered Call Option: Profit & Loss Calculations for Covered Call Option Trading: Options, Futures, Derivatives & Commodity Trading

# Covered Call Option: Profit & Loss Calculations for Covered Call Option Trading

Continuing further from our previous article on Covered Call Option: Example with Payoff Charts Explained, we cover the Maximum & Minimum Profit and Loss calculations from the Covered Call Option Trading. Let's see the payoff function again:

Hence, this final TURQUOISE or BLUE colored payoff function of Covered Call Option tells us that as a person trading on this Covered Call Option position, will have the following results:
1) if the price of the underlying goes below \$20, then he will start making a linear loss. The Maximum Loss will be of \$20, when the underlying stock price goes to ZERO i.e. the company goes bankrupt.
MAXIMUM Loss in a Covered Call Option Position = Buy Price of Stock - Premium Received from Short Call option

2) If the underlying stock price remains between \$20 and \$30, then the Covered Call Option trader will receive a linear positive payoff which will grow as the underlying stock price moves upwards (slanting part of the TURQUOISE color graph).

3) If the stock price continues to increase and reaches above the strike price of \$30, the horizontal part of the TURQUOISE color graph tells us that our profits will remain fixed at \$10 for this Covered Call Option.
MAXIMUM PROFIT in Covered Call Option Position = Premium Received from Short Call- Buy Price of Underlying Stock + Strike Price of Short Call

It is an incorrect fact stated on many websites that a covered call option has unlimited loss potential. As you can observe from the above graph and payoff function, the loss in Covered Call Option Position is limited and so is the profit.
Although the Maximum loss is higher than the maximum profit, but still both loss and profit in Covered Call Option Position are LIMITED. That's why it is known as the COVERED call, rather than a naked call option.

4) Similarly, there is a BREAK EVEN point for Covered Call Option Position.
Break even point is that point where you are in no profit no loss position. As can be seen from the BLUE or TURQUOISE graph, it touches the ZERO line at \$20. Hence, the Break even point of Covered Call Option Position = Purchase Price of Underlying - Premium Received from Short Call option

Please note that all the above mentioned values are NOT taking into consideration the brokerage and commissions for options trading. You Must account for all these charges as well, to come out with realistic profit and loss values.
 Posted by Shobhit See All Articles with