A covered call is a strategy in options trading that involves selling a call option on an underlying asset that is already owned by the trader.
Here is how it works:
- The trader buys shares of a particular stock or asset that they believe will either increase or remain stable in value.
- They then sell a call option on the same stock or asset, with a strike price that is higher than the current market price.
- In return for selling the call option, the trader receives a premium or payment upfront.
- If the stock price increases above the strike price of the call option, the buyer of the option may choose to exercise it and buy the shares at the strike price, which would result in the trader making a profit from the increase in stock price plus the premium they received from selling the call option.
- However, if the stock price remains below the strike price, the call option expires worthless, and the trader keeps the premium they received from selling the option, while retaining ownership of the underlying shares.
The covered call strategy is often used by traders to generate additional income from a stock they already own, while also providing some downside protection in the event of a decline in the stock price. However, it is important to note that this strategy does limit the potential upside profit of the stock, as the trader is obligated to sell the stock at the strike price if the option is exercised.