Question

A holder of XYZ stock currently selling at 45, decides to do a covered call write
by selling a six month 45 call. What are the advantages and risks to the trader in setting
up this position versus just holding a long position. Specifically, what expiry price
ranges in the stock would represent an advantage or disadvantage compared to a simple
long position.

Answer 1

Covered Call strategy- When investor is already holding the stocks and expects that stock price may come down in the future, he writes(sells) the same stock call of the same strike price. In this strategy, investor receives premium that is maximum possible profit.

Risk in this position- Whenever there is short position, risk is unlimited so writing a call bring unlimited risk.

Reward- Profit is limited to the premium received.

Payoff of covered call: For example; Investor writes a call at $5 then the payoff at different expiry prices will be:

Spot price at expiry	Profit/Loss from writing call	Profit loss in the stock position
35	+5	-10
40	+5	-5
45	+5	0
50	0	+5
55	-5	+10

Whenever stock goes down, he will gain profit but limited to the premium received, when stock price goes up, his loss will start that is difference between strike price and spot price but premium will be deducted in calculating loss. Investor also should consider his stock holding position, in which he is losing/gaining value as per the spot prices.

Long position is better than short position because in long position, profit is unlimited and loss is limited while in short position, loss is unlimited and profit is limited.