Covered Call Definition


The call option is an investment strategy where an investor combines holding a buy position in a stock and at the same time, sells call options on the same stock to generate an additional income stream. A stock holding with a covered call on it is slightly less risky than holding the stock normally, because your downside potential is slightly reduced by an amount equal to the option premium. As a holder of these shares, you’ll want to check to see which dividends you’re entitled to during the period prior to selecting the call option you want to sell. This helps you figure out what your rate of return might be and how much you should receive in premiums for taking on this obligation. Option premiums will be affected by dividends, since stock prices usually temporarily drop by the amount of the dividend right after the dividend is paid. A covered call is a popular income-producing options strategy that involves selling or writing call options against shares of stock that you already own.

option is exercised

Reverse Covered Call Writing: A Real-Life Example with SPDR S&P … –

Reverse Covered Call Writing: A Real-Life Example with SPDR S&P ….

Posted: Wed, 07 Dec 2022 08:00:00 GMT [source]

A covered call is a financial market transaction in which the seller of call options owns the corresponding amount of the underlying instrument, such as shares of a stock or other securities. If a trader buys the underlying instrument at the same time the trader sells the call, the strategy is often called a “buy-write” strategy. In equilibrium, the strategy has the same payoffs as writing a put option. The long position in the underlying instrument is said to provide the “cover” as the shares can be delivered to the buyer of the call if the buyer decides to exercise.

Possibility A: The stock stays under $47 at expiration

Based on the current price of the stock, that $100 represents 2% of your $5,000 investment in the stock, which is a pretty good income return for a three-month period. The maximum profit of a covered call is equivalent to the strike price of the short call option, less the purchase price of the underlying stock, plus the premium received. Long call options provide very bullish investors with great upside potential.

risk of losing

You can sell the call option anytime after you’ve purchased the stock. That said, it is a good idea to always exercise a bit of caution when dealing with options and options strategies due to the amount of risk involved. Morgan stock, a two-year call option LEAP serves as a “surrogate” for actual ownership of the underlying. In this scenario, you get limited protection from the downside thanks to the premium that you were able to pocket by selling the call option. This premium amount that you received can be used to reduce the impact of the loss that you had to suffer as a result of the fall in the stock price. Call option, the investor essentially locks in the price of the asset, thereby enabling him to enjoy a short-term profit.

How to trade Bitcoin strategies confuse many investors, but the covered call strategy is a relatively simple, low-risk way to boost your income. You have to be comfortable with trading off some of your upside potential, but the income that covered calls generate can be just what you need to make your investment portfolio perform the way you want. Combining options and stock positions can create unique investment exposure for investors. The practice of selling call options while also owning the underlying stock is known as selling covered calls. Read below to learn more about the appeal of covered calls, how investors can go about selling them. While our examples assume that you hold the covered position until expiration, you can usually close out a covered option at any time by buying it to close at the current market price.

Understand the difference between and uncovered options, learn how a covered call strategy works, and see examples. As you sell these covered calls, your dividend yield will be around 2.77% ($1.25/year), and your call premium yield will be about 5.66% ($2.55/year). Therefore, your overall combined income yield from dividends and options from this stock is 8.44% plus the potential for double-digit capital appreciation up to 13.33% annualized.

A covered call is an options strategy that can generate income, but it comes at a price.

Any historical returns, expected returns, or probability projections may not reflect actual future performance. While the data Ally Invest uses from third parties is believed to be reliable, Ally Invest cannot ensure the accuracy or completeness of data provided by clients or third parties. The below table shows how your investment gets impacted by stock price changes when you own a stock, compared with when you sell a covered call. With a covered call, the worst-case scenarios are that you have to sell shares that you own; or, the shares you own lose all of their value less the premium you earned. My suggestion is that you get a “feel” for non-linear decay by selling a covered call against 100 shares of stock that you own.

selling call option

The real risk of losing money if the stock price declines below the breakeven point. An example of an “overwrite” is when an investor has owned 500 shares for some time and now decides to sell 5 calls against those shares. The term “buy write” describes the action of buying stock and selling calls at the same time. The term “overwrite” describes the action of selling calls against stock that was purchased previously.

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The covered call is a great way for all investors to make a little extra money from their stock in a neutral market. Over the long run, however, owning the stock outright is usually more advantageous. As we can see, with the stock trading at $185 on expiration, our call option netted us a nice profit of $300! We purchased this option for $2 and on expiration, it is trading at $5. A long call consists of buying a single option; the covered call consists of selling one call option AND purchasing 100 shares of stock.

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Risk managed, not eliminated

This digital book describes my process for finding great stocks, and comes with streamlined calculators to determine fair value. Instead of running ads on this site, I receive affiliate commissions for recommending certain products or services. One of the first search results will be Nasdaq’s page on the dividend history of the company, which is the easiest source.

  • On the other hand, when the option expires out-of-the-money, the writer gets to keep the premium from selling the option.
  • Additionally, covered calls can profit in any market direction.
  • If you want to generate additional income, you should implement the covered call strategy in combination with dividend stocks.
  • Of course, this depends on the underlying stock and market conditions such as implied volatility.

Covered calls let you generate additional income from a portfolio of stocks. CFD trading may not be suitable for everyone and can result in losses that exceed your deposits, so please consider our Risk Disclosure Notice and ensure that you fully understand the risks involved. A call option is an option contract that gives the option buyer the right to buy an underlying stock at a specific price before or on a specific date. The specific price is called Strike Price and the specific date is called Options Expiration date. To own the right, you need to pay for the price of the option, which is called Option Premium.

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