Covered Call
What Is a Covered Call?
A covered call is an options strategy in which an investor holds shares of a stock and sells a call option on those shares. The investor receives a premium for selling the option while agreeing to sell the shares at a predetermined price if the option is exercised.
This strategy is commonly used to generate income from existing stock holdings.
Why It Matters
Covered calls can provide investors with additional income while holding stocks. The premium collected from selling the option can help offset potential losses if the stock price declines slightly.
However, the strategy also limits potential gains if the stock price rises significantly.
How Covered Calls Work
A covered call involves two components:
- owning shares of a stock
- selling a call option on those shares
If the stock price stays below the option’s strike price, the investor keeps the premium and retains the shares.
If the price rises above the strike price, the shares may be sold at the agreed price.
Example
An investor owns 100 shares of a company trading at $50 and sells a call option with a $55 strike price. The investor collects the premium while agreeing to sell the shares if the price exceeds $55.
Covered Call vs Naked Call
- Covered calls involve owning the underlying stock.
- Naked calls involve selling options without owning the stock, which carries higher risk.
FAQs About Covered Calls
Why do investors use covered calls?
To generate income from stocks they already own.
Is a covered call risk-free?
No. The stock price could decline, reducing portfolio value.
Does the strategy limit profits?
Yes. Gains may be capped at the option’s strike price.
Related Terms
