Covered Call Options Strategy

Covered call is a very simple options strategy to generate cash from your existing long stocks in the brokerage account.

What is a covered call ?
My Options blog entry explains “Call” option in detail. If you have long position in a security, you can sell calls on that underlying security. By selling a call on the “long” underlying security, you are executing a covered call strategy.

Why sell a covered call ?
Selling a covered call is a credit activity, i.e. once the transaction is executed, the amount for which the call was sold is credited in your brokerage account. It is a great way of generating extra cash on your existing securities. This is in addition to the dividends which you may get from the underlying security. By selling covered calls you can effectively reduce the cost basis of the underlying security also.

Risk and mitigation:
Being a conservative investor, I consider getting “assigned” for a covered call a risk. My intention is not to get assigned as I want to repeatedly sell covered calls on the same underlying security, once my existing covered call expires. In order to mitigate this risk, I try to sell covered calls which are deep out of the money.

Additional Considerations :
There is no guarantee that a deep out of the money call will not become (deep) in the money call. For a highly volatile stock this can translate into losing money if the current price of the stock is way higher than the strike price of the covered call.

Despite the above risks, selling covered calls is a simple options trading strategy which any investor can execute on a regular basis to generate additional income from their long stock positions.

This entry was posted on 23 Feb 2008 at 22:07 and is filed under Personal Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or trackback from your own site.