Covered Call

A covered call is a popular options strategy for investors who already own stocks and want to generate extra income from them. It’s a relatively conservative strategy, ideal for those bullish on a stock in the long term but believe it may not rise significantly in the short term.

In a covered call, a trader holds a stock (this is the “covered” part) and then sells a call option on that stock. Selling the call gives another trader the right to buy your stock at a certain price (called the strike price) before a specific date (the expiration date). In exchange for selling this right, you receive a premium – which you keep whether or not the stock is eventually sold.

How does it work?

Let’s break it down with an example.

Suppose you own 100 shares of XYZ stock, currently trading at $50 per share. You believe the stock will stay around this price in the near future. You sell one call option with a strike price of $55 and an expiration date one month away. For selling this option, you receive a $2 premium per share, or $200 in total (since each option contract covers 100 shares).

Here’s what could happen:

• If XYZ stays below $55 by the expiration date, the call buyer won’t exercise the option, and you keep both your stock and the $200 premium.
• If XYZ rises above $55, the buyer may exercise their option, forcing you to sell your 100 shares at $55. You still keep the $200 premium, plus any profit from the stock rising from $50 to $55.

In both scenarios, the covered call provides a way to enhance returns from stocks you already own.