Introduction
Covered calls are a popular options strategy used by investors to generate additional income from their stock holdings. This strategy involves selling call options on a stock that you already own 100 shares, or are “covering,” in order to collect the premium paid by the option buyer. The first thing you should know is what is a stock option. If you don’t, please see the post about options, then come back to this post.
How Covered Calls Work
To execute a covered call, an investor must first own shares of the underlying stock. They then sell call options on that stock to another investor, collecting the premium as income. If the stock price stays below the strike price of the call option, the option will expire worthless and the investor will keep the premium as profit. If the stock price rises above the strike price, the option will be exercised and the investor will be required to sell their shares at the agreed upon strike price.
Advantages of Covered Calls
One of the main advantages of covered calls is the income generated from the sale of the call option. This income can help offset any potential losses in the underlying stock, effectively reducing the investor’s risk. Covered calls can also potentially increase the overall return on the stock, as the income from the call option premium is added to any dividends received from the stock.
Disadvantages of Covered Calls
While covered calls can be a useful tool for generating income, they do have some potential drawbacks. One disadvantage is that by selling a call option, the investor gives up the potential for unlimited profit on their stock if the price rises significantly. In addition, if the stock price falls below the strike price of the call option, the investor will not be able to benefit from the potential capital appreciation of the stock.
Conclusion
Covered calls can be a useful strategy for investors looking to generate additional income from their stock holdings while potentially reducing their overall risk. However, it is important to carefully consider the potential disadvantages of this strategy, as well as the investor’s overall financial goals, before implementing covered calls.
Disclaimer
Once again, I am not a financial advisor. These tips are some things I have validated with my own personal experiences. If you feel you need more personal advice, please consult a professional financial advisor. Dont forget to check out the Book List for published authors on this topic!
