Understanding the Covered Call Payoff Diagram
A payoff diagram (also called a profit/loss diagram or risk graph) visually represents the profit or loss of an options position at every possible stock price at expiration. For a covered call, the payoff diagram has a distinctive shape: it rises linearly from left to right (like stock ownership) until it reaches the strike price, where it flattens into a horizontal line (the maximum profit cap). Understanding this shape is fundamental to grasping how covered calls work.
The covered call payoff is the combination of two components: a long stock position (which has unlimited upside and downside to zero) and a short call option (which caps your upside at the strike). When you overlay these two payoffs, the result is the characteristic covered call shape with a rising left side and a flat right side.
Payoff at Key Price Points
- 1Breakeven = $100 - $3.50 = $96.50
- 2Maximum profit = ($110 - $100 + $3.50) × 100 = $1,350
- 3Maximum loss = ($100 - $3.50) × 100 = $9,650 (if stock → $0)
- 4At $96.50: P&L = ($96.50 - $100 + $3.50) × 100 = $0
- 5At $100: P&L = ($100 - $100 + $3.50) × 100 = $350
- 6At $105: P&L = ($105 - $100 + $3.50) × 100 = $850
- 7At $110+: P&L = ($110 - $100 + $3.50) × 100 = $1,350
Complete Payoff Table
| Stock Price | Payoff/Share | Total P&L | Zone |
|---|---|---|---|
| $80 | -$16.50 | -$1,650 | Loss |
| $85 | -$11.50 | -$1,150 | Loss |
| $90 | -$6.50 | -$650 | Loss |
| $96.50 | $0.00 | $0 | Breakeven |
| $100 | +$3.50 | +$350 | Profit |
| $105 | +$8.50 | +$850 | Profit |
| $110 | +$13.50 | +$1,350 | Max Profit |
| $115 | +$13.50 | +$1,350 | Max Profit |
| $120 | +$13.50 | +$1,350 | Max Profit |
Anatomy of the Covered Call Payoff Curve
- Below breakeven ($96.50): The curve is in the loss zone. Losses increase $1 per share for each $1 the stock falls.
- At breakeven ($96.50): The curve crosses zero. Premium exactly offsets the stock decline.
- Between breakeven and strike ($96.50-$110): The profit zone. Profit increases $1 per share for each $1 increase in stock price.
- At strike ($110): Maximum profit of $13.50/share. The curve reaches its peak.
- Above strike ($110+): The curve is flat. Profit stays constant no matter how high the stock goes.
The covered call payoff is mathematically identical to a short put at the same strike price. This equivalence, known as put-call parity, means selling a covered call has the same risk profile as selling a cash-secured put at the same strike. Both strategies have a flat profit above the strike and linear losses below.
Comparing Payoff Diagrams
| Strategy | Below Breakeven | At Breakeven | Below Strike | Above Strike |
|---|---|---|---|---|
| Long Stock | Linear loss | Zero | Linear gain | Linear gain |
| Covered Call | Linear loss (cushioned) | Zero | Linear gain | Flat (capped) |
| Protective Put | Flat (limited loss) | Zero | Linear gain | Linear gain |
| Cash-Secured Put | Linear loss | Zero | Flat (max profit) | Flat (max profit) |