Widely viewed as a conservative strategy, professional investors write covered calls to increase their investment income. But individual investors can also benefit from this simple, effective option strategy by taking the time to learn it. Let's take a look at the covered call and examine ways that you can use it in your portfolio. As a stock owner, you are entitled to several rights. One of these is the right to sell your stock at any time for the market price. Covered call writing is simply the selling of this right to someone else in exchange for cash paid today.
This means that you give the buyer of the option the right to buy your shares before the option expires, at a predetermined price, called the strike price. A call option is a contract that gives the buyer of the option the legal right but not the obligation to buy shares of the underlying stock at the strike price any time before the expiration date. For the right to buy shares at a predetermined price in the future, the buyer pays the seller of the call option a premium.
The premium is a cash fee paid to the seller by the buyer on the day the option is sold. It is the seller's money to keep, regardless of whether the option is exercised. If you sell a covered call, you get money today in exchange for some of your stock's future upside. In this scenario, selling a covered call on your stock position might be an attractive option for you. Automate how you calculate covered calls, as well as other options investments, with the Options Outcome Calculator, included as part of Investopedia Academy's Options for Beginners course ].
As long as you have the short option position, you have to hold onto the shares, otherwise you will be holding a naked call , which has theoretically unlimited loss potential should the stock rise. Therefore, if you want to sell your shares before expiration, you must buy back the option position, which will cost you extra money and some of your profit.
You can use covered calls as a way to decrease your cost basis or to gain income from your shares, even if the stock itself doesn't pay a dividend. As such, this strategy can serve you as an additional way to profit from stock ownership. As options have risk, be sure to study all of your choices, as well as their pros and cons, before making a decision. Dictionary Term Of The Day. Broker Reviews Find the best broker for your trading or investing needs See Reviews.
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What is a Covered Call? Profiting from Covered Calls For the right to buy shares at a predetermined price in the future, the buyer pays the seller of the call option a premium. When to Sell a Covered Call If you sell a covered call, you get money today in exchange for some of your stock's future upside.
July 1 Total Profit: July 1 Total Loss: Covered Call Risks As long as you have the short option position, you have to hold onto the shares, otherwise you will be holding a naked call , which has theoretically unlimited loss potential should the stock rise. The Bottom Line You can use covered calls as a way to decrease your cost basis or to gain income from your shares, even if the stock itself doesn't pay a dividend.
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