Covered call

DEFINITION of covered call

A covered call is a financial market transaction in which the seller of call options owns the corresponding amount of the underlying instrument.

WHAT IT IS IN ESSENCE

Basically, that are shares of a stock or other securities. Writing (i.e. selling) a call generates income in the form of the premium paid by the option buyer.

In other words, the covered call is when a trader sells or writes call options in an asset that they currently have a long position on.

They are also known as buy-writes.

Selling a covered call enables you to make a profit out of an asset that you own, but only if its price doesn’t overstep the strike price of the option you’ve sold before it expires. In this example, the option will become worthless and you will collect the premium as profit.

If the asset’s price increases beyond the strike price, that can limit the profits to the difference between the strike price and the price at which you bought the asset. At this moment it is possible to buy an option with the same strike price and expiration. It will reduce the amount of potential profit you have lost.

Selling an option in an asset you don’t own is uncovered call.

Covered calls refer to options strategy where an investor holds a long position in an asset and writes (sells) call options on that same asset to cause an income flow.

This is often used when an investor has a short-term neutral view on the asset. And for this reason, holds the asset long. At the same time, an investor has a short position over the option to generate income from the option premium.

HOW TO USE

Covered Calls are one of the simplest and most effective strategies in options trading. The art and science of selling calls against stock involve understanding the true risks of the trade. But also, knowledge about what kind of outcomes you can have in the trade.

They give you a way to reduce volatility in your portfolio. And can give you a better basis in your trades. But you’ll need to learn how to select the best stocks and the best options for this strategy.