Basic option strategies: covered call, protective put and vertical spreads

What you will learn

• How a covered call and a protective put change the risk profile of a share position.
• How a bull call spread and a bear put spread limit both cost and profit.
• How to calculate maximum profit, maximum loss and break-even for each strategy at expiry.
• Which market view and which trade-off each strategy expresses.

Explanation

Single calls and puts, payoff diagrams and the Greeks were covered in lessons 4 to 7. Here we combine them. A strategy is a planned combination of positions opened together for one purpose. All figures are at expiry and use a contract multiplier of 100 (one contract = 100 shares); check the real multiplier in the contract specification.

Covered call

You own 100 shares and sell (write) one call on them. You receive the premium (the option price) immediately and accept the obligation to deliver the shares at the strike if the buyer exercises. "Covered" means you already hold the shares.

• View: neutral to slightly rising.
• Maximum profit: (strike − share purchase price + premium) × 100.
• Break-even: share purchase price − premium.
• Risk: almost the full share downside remains.

Protective put

You own 100 shares and buy one put. The put gives you the right to sell at the strike, so it works like insurance with a fixed price (the premium) and a deductible (the distance from the share price to the strike).

• View: rising, with a known worst case.
• Maximum loss: (share purchase price − strike + premium) × 100.
• Break-even: share purchase price + premium.

Vertical spreads

A vertical spread uses two options of the same type (two calls or two puts) with the same expiry but different strikes. You buy one and sell the other. The sold option reduces the cost but caps the profit.

• Bull call spread: buy a call with a lower strike, sell a call with a higher strike. You pay a net debit (premium paid minus premium received).
• Bear put spread: buy a put with a higher strike, sell a put with a lower strike. Also a net debit.
• For both: maximum loss = net debit × 100; maximum profit = (difference between strikes − net debit) × 100.
• Bull call break-even = lower strike + net debit; bear put break-even = higher strike − net debit.

Rule of thumb: a spread is a defined-risk bet on direction and distance. If you expect a moderate move, you give away extreme outcomes you do not expect anyway.

Worked example

Hypothetical example: a share trades at €50. Assumptions: European-style options, premiums in € per share, held to expiry. Fees, spreads, dividends and taxes are excluded.

1. Covered call. Buy 100 shares at €50, sell the 55 call for €2.00. Premium received: €2.00 × 100 = €200. Maximum profit: (€55 − €50 + €2.00) × 100 = €700, reached at any price of €55 or more. Break-even: €50 − €2.00 = €48. If the share falls to €40, the loss is (€40 − €50 + €2.00) × 100 = −€800.
2. Protective put. Buy 100 shares at €50, buy the 45 put for €1.50. Maximum loss: (€50 − €45 + €1.50) × 100 = €650. Break-even: €50 + €1.50 = €51.50. At €60 the profit is (€60 − €51.50) × 100 = €850; at €40 the loss stays at €650.
3. Bull call spread. Buy the 50 call for €3.00, sell the 55 call for €1.20. Net debit: €3.00 − €1.20 = €1.80, so €180 per spread. Maximum profit: (€5 − €1.80) × 100 = €320. Break-even: €50 + €1.80 = €51.80.

Covered call worst case: (€0 − €50 + €2) × 100 = −€4,800.

Common mistake

Practice activity

Hypothetical: you own 100 shares bought at €40 and sell the 44 call for €1.10 (multiplier 100). On paper, calculate (a) maximum profit, (b) break-even, (c) the result at expiry if the share ends at €47, and (d) the result if it ends at €36. Then calculate, for a bear put spread (buy the 60 put for €4.00, sell the 55 put for €1.80), the net debit, maximum profit and break-even.

Key takeaways

• Selling an option collects premium but gives up part of the payoff; buying one costs premium but limits risk.
• A covered call caps the upside and keeps most of the downside; a protective put caps the downside for a fixed cost.
• Vertical spreads define both maximum loss and maximum profit; always calculate both before entry.
• Break-even is the price that matters: the share must move beyond it, not just beyond the strike.

Next step

In the next lesson you will study CFDs in depth: how financing costs build up and which EU retail protection rules apply.