Covered Calls

An options strategy where an investor purchase a long position in a stock and sells a call options on the same stock in an effort to create income from the asset. This is often utilized when an investor has a short-term unbiased outlook on the asset and then keeps the asset long and concurrently has a short position through the option to produce income from the option premium.

As an illustration, you may have shares of the TSJ Sports Conglomerate. You’re considering the long-term prospects of TSJ’s share price but you assume in the short term the stock may trade a bit flat, perhaps within a few dollars of its current price of $25. Whether you choose to sell a call option on TSJ for $26, you may make the premium from the option sale but might cap your upside. Consider one of three different scenarios that will play out: a) TSJ shares trade flat, below the $26 strike price. The option will decrease and you keep the premium from the option. In this example, by using the buy-write option you have exceeded the stock. b) TSJ shares fall then the option closes worthless, you maintain the premium, and once again surpass the stock. c) TSJ shares rise above $26, the option is utilized and your upside is capped at $26, as well as the option premium. In this case, if the stock price goes higher than $26, as well as the premium, your buy-write strategy has underperformed the TSJ shares.

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