What is a Covered Call?
A covered call is a common options strategy used by long-term investors to generate additional income from their crypto portfolio. If managed correctly, selling call options against crypto holdings is a great way to generate positive yield in excess of the underlying asset’s absolute performance.
By selling a call option, the seller (writer) agrees to deliver the option buyer (holder) an underlying asset at an agreed-upon price level (strike price), at a fixed date in the future (expiration date). For this, the seller receives a payment (premium) from the buyer. The amount of premium received depends on several factors, including the duration of the contract, the underlying market volatility, and the proximity of the strike price to the current market price.
Unlike the seller, the holder of the long call option has no obligation to complete the financial transaction. Instead, they can decide whether to exercise their right to buy the underlying asset at the agreed-upon price — hence, buying an option.
By selling call options against crypto assets already owned, the underlying long position effectively hedges the short call (covers it). This ensures the seller can deliver if the option buyer exercises (calls) their option long.
Strike prices fall into one of three categories:
For call options, an ITM option represents any strike price that is below the current market price of the underlying security. An ATM option is a strike price equal to the current market price, and an OTM option is any strike price above the current market price.
Covered Call Setup
There are two factors to consider before selecting which strike best represents your market view:
The duration of the contract, or “days to expiration” (DTE)
How much the price of the underlying asset could move in that time
Typically, a longer-dated option commands a higher premium than a shorter-dated option. This is because the holder has more time for their option to generate profit. It’s recommended that sellers select a duration that pays an adequate premium, without tying them to an inflexible long-term contract.
Selecting the right strike price is equally important. For this, the seller must decide how far the strike price should be from the current market price. The lower the strike price, the higher the chance it expires ITM and is exercised by the holder.
Covered Call Strategy
The covered call is a neutral options strategy that works best when the price of the underlying crypto asset doesn’t move much while the contract is still active.
Because the short call limits the upside profit potential, a covered call may not be the best trading strategy for an aggressive investor (Upside Profit Potential = Strike Price + Premium Received − Transaction Costs). Similarly, the covered call options strategy performs less well in bearish conditions. If an investor believes the asset price will fall dramatically, it could make more sense to sell their crypto, as the received premium may not offset the drop in the underlying asset.
Another possible scenario is one in which an investor believes the asset price will fall in the near term, but rise in the longer term. Here, buying downside protection, such as a put option, could be a better alternative.
One way options traders assess the benefits and risks of a trade is to use “Greeks” to forecast how the position will perform in different scenarios. The Greeks are a set of financial measures that gauge the sensitivity of an option’s price relative to four key variables:
Delta is the rate of change in the option price for every $1.00 move in the underlying asset price. For instance, an ATM option, where the strike price is the same as the current price of the underlying, typically has a delta of 0.50. Here, a $1.00 move in the asset price results in a $0.50 change in the option premium. Delta increases as the strike price moves deeper ITM, and decreases as the strike price moves further OTM.
Volatility (Vega) measures how fast the market is moving. Higher implied volatility (IV) indicates a greater risk of large market moves. As IV increases, the prices of options contracts rise. In contrast, as volatility decreases, options prices typically drop.
Theta, often referred to as time decay, is the rate at which options prices lose value through the passage of time.
Gamma measures the rate of change in the option delta for every $1.00 move in the underlying asset. Gamma is at its highest when an option is ITM, and decreases as the option moves further away from the current price.
Who Is the Covered Call For?
Because the underlying long position guarantees the call writer can meet their obligations to the buyer, selling covered calls is a relatively low-risk move suitable for traders of all experience levels … as long as they have no immediate plans to sell the underlying crypto asset. That being said, knowing when to employ this strategy can help investors realize their maximum profit potential.
When to Use a Covered Call
The best time for an investor to open a covered call position is when they believe the underlying asset price will trade sideways — or slightly higher — between the time of the trade and the expiration date. The investor may be neutral, slightly bullish or even slightly bearish. The key takeaway is that the option must expire OTM for the seller to retain their underlying asset.
Apart from understanding the potential payout of an options strategy, it's also important to comprehend the risks involved. One way to measure the price at which a trade makes or loses money is to ascertain its breakeven point.
The breakeven point is the price at which a trade is neither in profit nor loss. For option buyers, it’s the point at which the value of the option increases enough to offset the premium paid. For sellers, it’s the point at which the option loses value equal to the amount of premium received.
When selling covered calls, the writer can work out their breakeven point by deducting the premium from the purchase price of the underlying asset (if acquired at the same time as writing the call), or from the underlying asset price at the time of writing the call (Mark to Market).
For instance, if an investor acquires one BTC at $20,000, sells a covered call and receives $500 in premium, the breakeven point is $19,500 (i.e., BTC Purchase Price − Premium Received).
Covered Call Sweet Spot
To effectively visualize the price at which an options position will either make or lose money, you can use a profit-and-loss diagram (AKA, a payoff diagram).
The payoff diagram below shows the profit-and-loss line (orange) of a covered call strategy, where the breakeven point is denoted by the intersection of the orange line with the price line (black).
Above the breakeven point, the profit increases incrementally until the asset price reaches the strike price (in this case, the sweet spot), at which point the position achieves the maximum potential profit.
Bearish Market Adjustments
One disadvantage of the covered call strategy is that it has limited upside profit potential in a rising market. Additionally, the trader will be exposed to significant risk if the value of the underlying crypto asset drops sharply.
There are, however, some methods traders can employ to reduce the odds of losing money. For instance, a drop in the underlying asset price normally results in the option losing value. Therefore, buying back the short call and selling a new strike price closer to the current market (rolling down) increases the amount of premium received. However, if the holder exercises their right to call the option, it also lowers the price at which the option writer is obligated to sell the underlying asset.
In more extreme market declines, the short call may be closed at a profit, and the proceeds put toward buying a near-term protective put option.
Maximum Take-Profit Potential
When using the covered call strategy, the best possible outcome is if the underlying asset price trades sideways or increases close to — but not above — the strike price at the time of expiration.
As long as the option expires OTM, the buyer is unlikely to exercise their right to buy the asset at the agreed-upon strike price. In that event, the seller keeps the premium and potentially generates profit on the underlying crypto asset.
Maximum Incurred Loss Potential
By selling a call option against your portfolio, you’re hedging against downside price risk and reducing your overall exposure to loss. However, the premium is unlikely to offset a larger drawdown in the value of the underlying crypto asset. Overall, the covered call strategy carries almost the same maximum incurred loss potential as an unhedged portfolio.
Covered Call Example
Suppose an investor purchases one BTC at a current market price of $20,000. Although they believe BTC will trade higher over time, they feel the price won't trade at or above $25,000 in the next 60 days. Here, the investor could sell an OTM call option with a strike price of $25,000 (or higher), expiring in 60 days. In return, the holder pays a purchase price of $500.
At expiration, there are two potential outcomes for the option writer:
BTC is trading above $25,000 — The option buyer exercises their option, and the option writer delivers to them one BTC at $25,000. Including the $500 premium, the option buyer's investment is $25,500.
BTC is trading below $25,000 — The option expires worthless. The buyer chooses not to exercise their call option. The writer keeps the $500 premium and their BTC long position.
In both cases, the option writer keeps the option premium. However, the outcome varies depending on how far BTC is trading from $20,000 at the time of expiration.
If BTC is above $20,000 but below $25,000, the seller keeps the $500 premium and also generates a positive return on their BTC long.
However, if at expiration BTC is trading below $19,500, the $500 premium doesn’t offset the loss on the underlying asset. Similarly, if the price is above $25,500, the investor would have made more money by simply not selling the call option.
Here are some ways to enhance the potential profit from a covered call strategy:
Sell short-dated calls with between 30–60 days to expiration, to maximize time decay and allow flexibility to adjust the position if needed.
Look for signs that the market is moving from a high volatility environment to a lower volatility environment.
Choose a strike price at a level at which you’re happy to sell the underlying asset if the buyer exercises their right.
Thanks to Bybit's Portfolio Margin mode, USDC derivatives account holders with a minimum net equity of 1,000 USDC can benefit from preferential margin requirements when trading USDC perpetual futures and options contracts.
Portfolio Margin mode uses a risk-based approach designed to reduce margin requirements. Like SPAN, Portfolio Margin mode combines active open positions to determine overall portfolio risk. This method reduces the margin requirement for a covered call strategy by netting the long position (underlying asset) against the short position (short call).
Theta Decay Impact
Theta decay is the main reason the covered call strategy is so widely used. All things being equal, the option premium loses value as it approaches expiration, and thus works in the option seller’s favor. As shown below, theta decay accelerates as the contract gets closer to the expiration date. For this reason, options sellers benefit from holding their short positions for as long as possible.
Source: Born To Sell
Implied Volatility Effect
The covered call writer takes the view that implied volatility will either remain the same or decrease. Higher IV works against the covered call strategy, whereas a drop in IV is helpful for the option writer, resulting in lower options prices.
Long-term holders can generate a passive income against their crypto portfolio
Selling covered calls acts as a partial hedge against a decline in the underlying asset
Theta decay works in the strategy’s favor
The strategy limits potential upside gains
A covered call doesn’t offer protection against large drawdowns
Traders may be charged additional transaction fees if they adjust the position by rolling down.
Before opening a covered call position, here are three things to consider:
Is there sufficient margin to cover extreme market volatility?
Do you possess the required level of knowledge to manage the position in adverse circumstances?
Are you comfortable with all potential outcomes of the strategy?
If you are unsure on any of the above points, don’t worry — you can take advantage of our free educational resources to learn as much as possible before embarking on your options trading journey. By following these steps, you can assess which covered call strategy provides the best opportunity for generating income — at a level of risk you’re comfortable with, and in accordance with your investment objectives.
A variety of options trading strategies are available, each with different characteristics and risk levels. Like clothes, there’s no one-size-fits-all: Though not all strategies may suit every investor, covered calls are definitely a beginner-friendly way for investors to enhance the returns of their crypto portfolios. When managed correctly, covered call writing offers a unique way to make money and hedge crypto holdings against market setbacks. For those willing to learn, you can start trading the wide array of options listed on Bybit any time you’re ready.