Module 8 · Lesson 13 of 13 · Options · About 5 minutes
Covered Calls and Cash-Secured Puts: Payoff Shapes and Trade-Offs
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Before you read: Vertical Spreads: Defined-Risk Payoffs With Two Strikes
What you will learn
- How a covered call combines owned shares with a sold call.
- How a cash-secured put combines set-aside cash with a sold put.
- Why their payoff shapes are similar, and what risks remain.
What is a covered call?
What do you give up in exchange for the premium?
A covered call holds 100 shares and sells one call against them. In a fictional example, shares bought at $50 and a 55 call sold for $1.50: if price ends above $55, the shares are likely called away at $55, for a total gain of $6.50 per share. If price falls, the premium offsets only $1.50 of the decline; below $48.50 the position loses money, and the loss can grow to nearly the full share value.
What is a cash-secured put?
What happens if the stock falls below the strike?
A cash-secured put sells a put while holding enough cash to buy the shares if assigned. Selling a fictional 45 put for $1.20 with $4,500 set aside: above $45 at expiration, the premium is kept. Below $45, the shares are likely bought at $45, an effective cost of $43.80, even if the market price is much lower.
Payoff diagram
Illustrative diagram constructed for teaching. Not real market data.
The diagram shows two fictional expiration payoffs: a covered call capped at +$6.50 above 55 and crossing zero at 48.50, and a cash-secured put capped at +$1.20 above 45 and crossing zero at 43.80. Both slope down to the left. All values are made up.
Why do they look alike?
Why do the two payoff diagrams have the same shape?
At expiration, both have limited upside (the premium, plus the gain to the strike for the covered call) and large downside if the stock falls. With the same strike, expiration and underlying, this similarity follows from put-call parity, before interest, dividend and early-exercise effects. The two fictional examples above use different strikes, so their numbers differ. Neither removes the risk of owning shares; each trades some upside for premium. Describing the premium as regular cash flow does not make these positions low-risk.
What this does not tell you about these positions
- Whether either suits anyone.
- Values before expiration or dividend effects.
- Tax treatment. Ask a tax professional.
- Nothing here recommends any option trade.
Method in Practice: including assignment
Fictional example. John, Harbor Index futures, the prices, times, costs and results are all invented for teaching. This shows how a written plan can be built and tested. It is not a recommendation, and nothing here says how often this idea works.
Try it on a real chart. Test this idea yourself on past sessions with bar replay. Keep your own count, including the days with no trade.
The idea. A covered call trades away gains above the strike for the premium. A cash-secured put can turn into buying shares at the strike even after the market price has fallen below it (this lesson). John's written limits: he only writes calls on shares he'd be content to sell at the strike, and only sells puts with the full cash set aside for shares he'd be content to own.
Three outcomes (adapted: three positions, each followed to expiry)
-
Covered call expired: kept the premium → +$59.35
-
Covered call assigned: shares sold at $103. Holding would have made $700; the covered call made $559.35
-
Cash-secured put assigned: bought 100 shares at $95 with the ETF at $93. Down $145.65 on paper
Show the full replays
(John owns 100 ETF shares bought at $98.00)
| Position | At expiry | Result after costs |
|---|---|---|
| Sold the 103 call for $0.60 | ETF $101.00: the call expires | +$60 − $0.65 = +$59.35 premium (the shares are still held) |
| Sold the 103 call for $0.60 | ETF $105.00: assigned, shares sold at $103 | Shares +$500, premium +$60, −$0.65 = +$559.35. Without the call: +$700 |
| Sold the 95 put for $0.55, with $9,500 set aside | ETF $93.00: assigned, buys 100 at $95 (effective $94.45) | Marked at $93: −$200 + $55 − $0.65 = −$145.65 unrealized |
Test it yourself
- Before writing a call, write down whether you're content to sell at the strike.
- Before selling a put, check the full cash is set aside, and that you'd be content to own the shares.
- Work out each position's result at three expiry prices before opening it.
Where it breaks
- The covered call caps the gain (the assigned replay).
- The put can be assigned when the price has fallen well below the strike.
- Values before expiry, dividends and taxes aren't covered here.
Reflection question: For each option you sell, have you written down the result you'd accept if it's assigned?
Check yourself
- In the fictional covered call, what is the break-even at expiration? Hint: purchase price minus premium.
- What is the effective purchase price if the fictional put is assigned? Hint: strike minus premium.
- Why do both positions keep most of the downside risk? Hint: who owns, or may own, the shares?
Reflect on your own process
- Does your written plan state what you would do with the shares, or the cash, if assignment happens?
- When you record premium received, does your journal also record the stock downside that remains?
- How would you check that two positions you call equivalent really share the same strike and expiration?
- For each option you sell, have you written down the result you'd accept if it's assigned?