A covered call is an option trading strategy where an investor holds a long position in an underlying asset, typically stock shares, and simultaneously sells call options on that same asset. This means the investor owns the shares and "covers" the option position by having the shares ready to deliver if the option is exercised. The goal of a covered call is to generate additional income from the premiums received by selling the call options, while still holding onto the underlying shares. The strategy is often used when the investor expects only a minor increase or neutral price movement in the stock during the option's life. If the stock price stays below the option's strike price, the option expires worthless and the investor keeps the premium as income. If the stock price rises above the strike price, the investor may have to sell their shares at that strike price, thus capping their upside potential but still benefiting from the premium received. Key points:
- You sell call options on stock you already own.
- You receive income from the option premiums.
- The upside gain on the stock is limited to the strike price of the call.
- The strategy is used when you expect little price movement or moderate gains.
- You are obligated to sell the shares if the option is exercised.
In essence, a covered call allows you to earn extra income on your existing stock holdings with some downside protection, but at the cost of limiting how much you can profit if the stock price rises sharply. It is a popular conservative strategy among investors who want to generate income with the stocks they hold without selling them immediately. This strategy can also be referred to as a "buy-write," if the stock is bought and the call option sold simultaneously, or "overwrite" if the call is sold on stocks already owned. So, a covered call is a way to earn premiums from options while being prepared to sell the underlying stock at a predetermined price if required. It is favored in markets with expected low to moderate stock price changes.
