The covered call options trading strategy consists of an investor buying or holding a long position in an asset and writing (selling) call options on that same underlying asset.
A call option is an agreement that gives an investor the right, but not the obligation, to buy an asset at a specified price within a specific time period.
So, in this strategy the investor effectively sells the right to buy the asset at a specified price within a specific time period, while simultaneously owning the underlying asset.
When an investor buys the underlying asset at the same time as selling the call, the strategy is often referred to as a buy-write strategy.
In writing the call options, the investor earns a premium - the income received for selling an option contract to another party. The premium is the price paid to acquire the option, a cash fee paid to the option seller by the buyer on the day the option is sold. The premium income earned serves as a hedge to offset the downside risk or to potentially add to the upside return.
However, for as long as the short call position is open, the investor forfeits much of the upside potential in the asset's price. If the asset price rises above the strike price, the call option is likely to be exercised. The strike price is the price where the asset can be bought in the period up to the expiration date.
This strategy suits the investor who has a short-term neutral to mildly positive outlook for the underlying asset - someone who is expecting the asset price to be steady or rising slowly until the expiration date of the option.
SEE: The Basics Of Covered Calls
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