A covered call is a strategy that involves trading potential capital appreciation in the future for cash today.
A covered call is one of the most used option strategies. This strategy can be used to generate additional income from the equity in an investment portfolio. It involves selling a short call against a long equity position. The long position could be a variety of assets, most of the time it will be stock or ETF positions.
For review, a call is an option contract in which the buyer of the contract has the right to purchase the underlying security at a fixed price (known as the strike) from the seller. The seller in turn has the obligation to sell the security at the strike price.
The seller of the option collects cash (called the premium) for selling the option. Collecting this premium is how this strategy generates income. By owning the underlying asset you are “covering” this call.
One of several important details in covered call writing is which strike price to utilize. A further “out-of-the-money” strike generates less premium for the seller. The buyer of your call is agreeing to pay a higher price, so they are less willing to compensate you. This does allow you to enjoy more capital appreciation on the long position. Selecting a further strike can also lower the probability that your shares are called away.
There are many considerations to weight before you make any investment decision. Options in particular carry special risks and are not suitable for all investors. Please do your own research or feel free to contact us if you have any questions!
