COVERED CALLS

A COVERED CALLS occurs when a buyer sells a call option on an asset owned by the seller that has a predetermined strike price and expiration date of the seller.

Individual investors who take the time to understand how covered call options work and are right to use them can also use covered call options as a strategy that aims to provide both safety and success in achieving your financial goals.

In the following sections, you’ll learn how a covered call can help you improve your investment performance and increase your income while reducing the risk in your portfolio.

How exactly do COVERED CALLS work?

The ability to sell an asset at any time at a price determined by the market is one of the many benefits of owning stock or futures contracts.

If you sell this right through covered call writing and accept payment for it, you can give someone else the opportunity to buy your security on or before the expiration date, also known as the strike price.

The buyer of a call option has the right, but not the obligation, to acquire the underlying stock or futures contract at the option’s strike price before the option’s expiration date.

COVERED CALLS: a proven way to earn extra income

The buyer of a call option pays the option writer a premium for being able to buy the stock or contract at a predetermined price sometime in the future.

As a result, the covered call strategy achieves the highest return on investment (ROI) when the price of the underlying stock is higher than the strike price and long stock positions generate profits.

If the buyer of a covered call does not exercise the option before expiration.

because he does not believe the price of the underlying stock will rise, the seller of the call receives the full premium from the sale of the option. Because the writer of the call wrote the option contract.

When is it advisable to sell covered calls?

When selling a covered call, the price paid for the payout is the future appreciation of the underlying asset. Let’s say you decide to invest $50 in XYZ stock that after one year will reach $60 per share and gain 20%.

Additionally, you are willing to sell the stock for $55 in the next six months, giving up potential future profits in exchange for an immediate gain.

Selling a covered call as part of this transaction may be advantageous depending on the situation. In this situation it is likely to be profitable to sell a covered call on the position.

Benefits of using covered calls

The practice of selling covered call options for a potential profit over the strike price and a premium over the life of the contract can help reduce downside risk or maximize profit as an objective.

This decision results in a smaller profit than if the seller had simply held XYZ stock and let it close at $59 instead of selling it.

If the stock price falls below $59 per share at the end of the six-month period, the seller will either realize a profit or lose less than they would have otherwise. Because the seller’s breakeven point will be lower.

Covered calls have several inherent disadvantages

“Naked call holders” are sellers who do not own shares or contracts underlying call options. This exposes ‘bare call holders’ to potentially unlimited risk if the value of the underlying security increases.

Conclusion

Covered calls are an option that can be considered low-risk for option holders looking for income. Covered calls are particularly attractive to retirees who don’t intend.

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Written by Patna Motihari

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