Options strategy: covered calls

Covered call is an options strategy where the owner of a particular stock writes or sells a contract against the stocks owned in exchange for a premium. This strategy can deliver a steady income since the call writer receives the premium as soon as it is opened. It is also a safe strategy as long as the underlying stock does not fall in price far enough that it errodes the value of the premium received. When selling calls, writers benefit more if the stock they own does not get called away or exercised by the buyer of their call. This happens when the current market price of the stock does not reach the strike price stated on the contract. When their stock is not called away, the call writer can write another covered call option after the contract reached its expiration date.

Covered call is very effective on a sideways market where the price of the underlying stock does not fluctuate on a wider band. This is reversed and ineffective if the underlying stock is volatile so a covered call is only recommended on less volatile stocks. Since selling a call means giving up control of the stocks owned to the call buyer, the writer is helpless when the stock falls continually. In this scenario, the stocks owned by the writer would not be called away but he will suffer a significant loss due to the fact that he cannot sell the stocks until the contract expires. A way to avert this loss would require the writer to buy back the call he wrote at a slight loss to regain control of the stocks. Since the action taken is sell to open when the call is sold, buy to close is the action required to regain control of the stocks at the broker screen. If the writer chooses an out of money strike price, his gains are limited to the premium received and the profits generated by the underlying stock when it gets called away at a higher price.





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