A covered call is an option strategy where an investor writes a call option for a stock that he already owns.
The covered call is a conservative but effective strategy that can be used to generate small profits. This article will explain everything there is to know about the covered call and give investors confidence to add this strategy to their investing playbook.
The covered call is used when an investor expects the underlying stock to have a slight increase or decrease in price. This is not a strategy to use when an investor is heavily bullish, or bearish.
By using this strategy, an investor walks away with a premium regardless of what happens to the underlying stock’s price. However, this strategy puts a cap on the stock’s profit potential.
Let’s look at an example to gain a better understanding.
Assume an investor owns shares of stock ABC. ABC is trading at $20. The investor sells a call option for ABC that expires in a month with a strike price of $23. The investor receives a premium of $2 per share for selling the option. However, he caps his potential upside on the stock at $23.
This example will play out in one of three scenarios:
These three scenarios show the possible results of executing the covered call strategy. An investor will get his best result from the strategy if the stock price remains relatively neutral. If this happens, the investor walks away with the premium while still owning shares of the stock.
The covered call is a safe and effective strategy that investors can use to earn small profits in option trading.
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