Covered call

From Traderpedia

Writing a call for shares of stock that you own.

[edit] Introduction

The covered call is a strategy in which a trader writes a call option contract while at the same time owning an equivalent number of shares of the underlying stock. This strategy is the most basic and most widely used strategy combining the flexibility of listed options with stock ownership.

[edit] Description

Though the covered call can be utilized in any market condition, it is most often employed when the investor, while bullish on the underlying stock, feels that its market value will experience little range over the lifetime of the call contract. The investor desires to either generate additional income (over dividends) from shares of the underlying stock, and/or provide a limited amount of protection against a decline in underlying stock value.

While this strategy can offer limited protection from a decline in price of the underlying stock and limited profit participation with an increase in stock price, it generates income because the investor keeps the premium received from writing the call. At the same time, the investor can appreciate all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares. The covered call is widely regarded as a conservative strategy because it decreases the risk of stock ownership.