Long Call vs. Covered Call: Option Strategy Comparison

Long call and covered call approaches both involve call options, but they serve very different purposes in a portfolio. A long call is typically a speculative strategy, allowing investors to profit from a stock’s upward movement with limited upfront investment. A covered call, on the other hand, is more conservative, often used by stockholders who want to generate additional income from their holdings.

A financial advisor can help you determine when to use a long call or a covered call for your investment strategy.

What Is a Long Call?

A long call is one of the simplest options trading strategies. It involves purchasing a call option, which gives the investor the right (but not the obligation) to buy a stock at a predetermined strike price before the option expires.

With a long call, the investor pays a premium for the option. If the stock price rises above the strike price plus the premium paid, the investor can exercise the option for a profit or sell the option contract for a gain.

Losses are limited to the premium paid, while the potential profit is unlimited as long as the stock continues to rise.

Let’s take a look at an example. Suppose an investor buys a call option on XYZ stock with a strike price of $50, paying a $3 premium. If XYZ rises to $65, the option is worth $15 ($65 – $50). Subtracting the $3 premium, the investor nets $12 per share in profit. If the stock remains below $50, the option expires worthless, and the investor loses only the $3 premium.

When to Use a Long Call

A long call is a useful strategy for when you have a bullish outlook on a stock but want to limit your downside risk. It’s also useful for investors with smaller amounts of capital who want leveraged exposure to price movements.

Pros

Low upfront cost
Limited loss potential
Unlimited upside

Cons

Time decay erodes value
High probability of expiring
Worthless if stock does not move

What Is a Covered Call?

In a covered call, the investor sells a call on shares they own, keeping the premium if the stock stays below the strike price.

A covered call is an income-generating strategy that combines stock ownership with selling call options against those shares.

With a covered call, the investor owns at least 100 shares of stock and sells a call option with a strike price above the current market price. The investor collects a premium from the sale. If the stock remains below the strike price, the option expires worthless, and the investor keeps the premium as income. If the stock rises above the strike price, the option may be exercised, and the investor must sell their shares at the agreed strike price.

The strategy provides income through premiums, but caps the upside potential since gains above the strike price are forfeited.

Here’s an example: Let’s say an investor owns 100 shares of XYZ stock trading at $50. They sell a covered call with a $55 strike price and collect a $2 premium per share ($200 in total). If XYZ stays below $55, the option expires worthless, and the investor keeps the $200 premium. If XYZ rises to $60, the investor is forced to sell at $55, limiting their profit but still keeping the $200 premium.

When to Use a Covered Call

A covered call can make sense when you have a neutral to mildly bullish outlook on a stock. Investors often use it when they already own shares and want to generate additional returns while holding them.

Pros

Generates income,
Provides limited downside protection
Can work well in flat markets

Cons

Caps upside potential
Still exposes investor to losses if stock declines significantly

Long Call vs. Covered Call: Key Differences

While both strategies involve call options, their purposes and risk profiles differ substantially in several key areas:

Investment objective: A long call is for speculation on rising stock prices. Meanwhile a covered call is for generating income from owned shares.
Capital requirements: A long call requires only the premium cost, making it accessible with less capital. A covered call requires stock ownership, often a much larger investment.
Risk tolerance: Long calls carry the risk of losing the entire premium but no more. Covered calls carry stock market risk if the stock declines, though the premium provides a small cushion.
Return potential: Long calls have unlimited profit potential. Covered calls have capped upside but consistent income through premiums.

Tax Implications of Long Calls vs. Covered Calls

Taxes are another important factor in deciding between a long call and a covered call.

With long calls, profits are taxed as capital gains—short-term if held under a year and long-term if held over a year. Losses may offset other capital gains.

With covered calls, however, the premium income is taxed as short-term capital gains, even if the stock is held long-term. If the stock is sold when the call is exercised, any gains are subject to capital gains tax based on the holding period.

Because tax rules can be complex, especially for options, it’s often worth consulting with a financial advisor or tax professional.

Long Call vs. Covered Call: Which Is Right for You?

The decision between a long call and a covered call comes down to your investment goals, risk tolerance and market outlook.

If you want leveraged exposure to a rising stock with limited downside, a long call may be the better fit. On the other hand, if you already own shares and want to generate income while capping your upside, a covered call may be more appropriate.

Bottom Line

A long call bets on price gains with limited risk, while a covered call earns income from premiums but caps upside.

A long call lets an investor control a stock for a set time and profit if the price rises above the strike, risking only the premium paid if it does not. A covered call involves owning the stock and selling calls against it, generating income from premiums while capping upside if the stock rises beyond the strike. The long call is growth-oriented and higher risk, while the covered call is income-oriented and more conservative.

Investment Planning Tips

A financial advisor can help you develop an investment strategy and manage risk for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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