DefinitionĀ§
Covered Call: A covered call is an options strategy where an investor sells call options on an asset they already own, thereby generating income (from option premiums) while being prepared to deliver those shares if the option is exercised.
| Covered Call | Naked Call |
|---|---|
| The investor owns the underlying asset | The investor does not own the underlying asset |
| Generates income via premiums | Exposes the investor to unlimited potential losses |
| Lower risk | Higher risk |
| Ideal for neutral-to-bullish markets | Suitable for bullish outlooks only |
ExampleĀ§
Imagine you have 100 shares of Stock A, which you purchased for $50 each. Youāre optimistic about the stock enabling you to sell a call option with a strike price of $55. If the stock price remains below $55, you keep your shares and the income from the option premium. If the stock price exceeds $55, youāre likely to sell your shares at that price, but still profit from the premium!
Related TermsĀ§
- Call Option: An agreement granting the buyer the right to purchase the underlying asset at a specified price before a specific date.
- Put Option: An agreement that gives the buyer the right to sell the underlying asset at a specified price before expiration.
FormulaĀ§
Calculating the potential income from a covered call can be as simple as pie:
Mermaids in Mermaids šĀ§
Humorous CitationsĀ§
- āSelling covered calls is like entering the peach cobbler business: you canāt just have the peaches, you need the perfect crust ā or in this case, the stocks!ā š
- āI once sold covered calls on my indoor plantsā¦ Letās just say the only thing blooming was my desperation!ā š±
Fun FactsĀ§
- Investment in Limbo: A covered call is like holding cash under your mattress while renting out your air foundation ā sounds good until the mattress goes up in flames!
- Historically, the strategy first emerged to help farmers hedge against bad crop years; they sold their future harvest as options! š¾
Frequently Asked QuestionsĀ§
Q: What happens if the stock price skyrockets?
A: You might miss out on potential huge gains on the upside if the stock price skyrockets. But hey, at least youāll have the option premium!
Q: Is the covered call strategy suitable for all investors? A: Not really; itās best for those who want a steady income and donāt expect wild stock price movementsāideal for conservative souls looking for a little extra cash!
Further Reading & ResourcesĀ§
- Investopedia - Covered Calls - A deep dive into covered calls.
- Books:
- āOptions as a Strategic Investmentā by Lawrence G. McMillan ā A classic that explains various options strategies in detail.
