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Options Strategies
"Sell Covered Call" Option Investment Strategy
by InvestorGuide Staff (Write for us!)
(Click on the links within the article to get definition of that word)
A call option is a contract that gives an investor the right, but not the obligation, to buy 100 shares of the underlying
stock. If you own a call option, then you are known as the "holder." If you sell a call option, then you are the
"writer." A call option assumes that the value of the underlying stock will rise to at least the strikeprice
by the expiration date (put options are the opposite, and expect value to decrease).
Holders of call options must pay a premium when purchasing the investment.
The writers of call options, on the other hand, will
receive that premium - whether or not the holder ever decides
to exercise the option or not. If the writer of the call option actually owns the underlying stock, then it is known
as a "covered call." When the writer does not own the underlying stock on the option, it is referred to as a "naked call."
Though the sell covered callstrategyworks best when stock prices remain steady, investors should research the
underlying stock to gauge the direction of stock prices. If you are only slightly convinced that prices will remain
the same, protect the sell covered call tactic by selling options at lower strike prices.
Since lower strike prices are less of an investment risk for the buyer of the option, they will command higher premiums.
However, if you believe that stock prices may also rise (but not actually reach the strike price), sell options at
higher strike prices. Of course, if the stock price falls, you will pocket the premium as the option
will go unexercised.
Writing a covered call is about minimizing risk and maximizing profits. The investor typically doesn't really know
if the price will go a little up or a little down - just that there will be some fluctuation in the near future.
In the "sell covered calls" option strategy, the investor is certain that the price of the stock will
not decrease (because if the investor is certain the price will decrease then the better option is to outright
sell the stock instead). Therefore, he/she will be writing "covered call" options and making a profit from the premiums
paid by other investors. If an investor is not entirely convinced that prices will not drop, then he/she should sell
at a lower strike price. This will increase the premium amount that
can be charged for writing the option
as it is less risky for people to purchase an option with a lower strike price.
Loss is limited using the "sell covered call" option strategy because the writer actually owns
the underlying stock. Loss equals the difference between the market price and the strike price
(market price will be higher than strike price) but is offset to an extent by the premium received when
selling the option. The potential for profit using this strategy comes in if the market value of the stock
does not rise at all and the options goes unexercised and the premium is pocketed or if the market value
rises above what was paid to purchase the stock but doesn't rise all the way to the strike price (in this case
after the option expires, the stock can be sold at a higher price in the open market and the profit from this sale
plus the premium received from writing the option will be the total profit from the strategy).
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