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. An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.If the trader buys the underlying instrument at the same time as he 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.
Maximum Loss: Unlimited on the downside.
Maximum Gain: Limited to the premium received from the sold call option.
Characteristics
When to use
When you own the underlying stock (or futures contract) and wish to lock in profits.
This strategy is used by many investors who hold stock. It is also used by many large funds as a method of generating consistent income from the sold options.
The idea behind a Covered Call (also called Covered Write) is to hold stock over a long period of time and every month or so sell out-of-the-money call options.
Even though the payoff diagram shows an unlimited loss potential, you must remember that many investors implementing this type of strategy have bought the stock long ago and hence the call option’s strike price may be a long way from the purchase price of the stock.
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