Covered Call

by Investing School on November 2, 2010

A covered call – sometimes referred to as a buy-write – is an options strategy. The investor will hold a long position in an asset and will then write or sell call options on that particular asset. This is done to generate additional income on the asset, most commonly when the investor has a neutral opinion on the asset and this is the reason for the long hold in conjunction with the short position.

If the stock price is stable or goes higher, then the investor is able to keep the income as earnings despite the fact that the profit may have been higher if there were no call that was written at all. If the price of the stock goes down, then the investor will most likely not make a profit.

Let’s say, for example, that an investor has acquired 500 shares of a certain stock. The value of the stock is $10,000. He decides to sell 5 call option contracts and the amount is $1,500 per contract. This will cover the amount of the decrease in the stock. You cannot prevent losses in a covered call position but you can reduce them. If the price of the stock is lower, then it would not be wise for the option buyer to exercise the option at the price strike that is higher because the stock is now able to be purchased at a lower market price. The writer or seller will be able to keep the money that is paid on the premium.

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