Covered Call Strategy: Overview and Advantages

Do you want to boost your income without giving up on your stock ownership? Then, here's your solution! With a covered call strategy, you can make extra profit from your existing stocks whenever you want. Such a covered call option strategy can protect you during unexpected stock drops.

If you do not know much about this options strategy, read this article until the end. It will cover its meaning and advantages in detail.

What is a Covered Call Strategy?

A covered call strategy can help you earn extra income on stocks. Through this strategy, you can sell a call option at a set price known as the ‘strike price’ within a certain time range. When someone buys your call option, you get a premium. 

If your price stays below the strike price, you can keep the stocks; if not, you might have to sell your stock at that price. However, you can keep the premium either way. This strategy is perfect when you know that the stock price will not rise too much.

Key Benefits of Using a Covered Call Strategy

Having a covered call strategy can provide you with many benefits that will bring you profit. Here are a few of those benefits.

Extra Income:

A covered call can provide you with extra income. You can receive a premium by selling a call option, and you might also get to keep your stock. It is especially beneficial for people who are looking for returns in slow-rising markets.

Managing Risks:

The premium you receive can help you when your stock rate suddenly declines. Slight changes in stock prices can be easily managed and help reduce overall loss through that premium.

Controlled Selling:

You can set the strike price according to your preference, which is why you can manage your profits and losses. You can control the price at which you want to sell so that you can get a profit from the strike price.

Risks Associated with Covered Call Options

Although there are several benefits of covered call options, they also have certain risks to them. Here are a few of those risks:

Stock Ownership Risk

Since you own the stock, any price rise and fall will completely affect your profits. If the stock drops unexpectedly, you will receive a significant loss, and your premium might not cover those losses.

No Protection from Major Decline

The premium you earn by covered call can only protect you against small declines in stock prices. With significant losses, you will be uncovered, which will lead to heavier risks of stock ownership.

Premature Assignment Risk

If the buyer of the call option exercises the option early, then you will have to forcefully give away your shares before you want to. If you end up selling covered calls too early, you may lose your chance to earn more profit.

When to Implement a Covered Call Strategy

A covered call strategy is best implemented when you know exactly whether the stock's price will rise or fall. You can also implement it if you have a price in mind and are comfortable selling it.

You can set up a strike price near your target, earn a premium, and then sell your stock later. Moreover, during a slightly bullish or bearish market, your covered call options will be stable, and you will profit from them later.

Example of a Covered Call Strategy in Action

An example in action can help you understand a covered call strategy better. For example, if you own 100 shares of a company with a current stock price of 50 per share, you can decide on a covered call strategy if you expect the stock to rise or fall. 

If the strike price reaches 55 per month, then the buyer might not buy the option, and you can keep both the share and the premium. However, if the price keeps rising after 55 and the buyer decides to buy the share for 55, then you are still left with the premium amount.

Conclusion

Covered call strategies are the best options to get maximum returns on your current stock holding. Hopefully, with this guide, you will understand more about the covered call option strategy and can now make a decision on your profit potential market. However, it would also be advisable that you consult a financial expert before using this strategy to avoid any mistakes.

FAQs

Q1. What are the advantages of covered calls?

With covered calls, your risks and downsides will be limited. Moreover, you can also sell your covered call to earn money. It is ideal for people who seek above-average incomes with increased returns.

Q2. What is a covered call strategy? 

A covered call is a financial transaction where you can sell options on your stocks. You will be covered since the stocks will already be yours, so you can sell them when needed. Thus, the term ‘covered’ comes into play.

Q3. Is there a downside to covered calls?

Covered calls can also have a few downsides. This method is not very profitable for bullish strategies since you can make more money without covered calls. Moreover, one needs to deliver 100 shares for every call option sold.

Q4. Can you ever lose money on a covered call? 

Yes, losing money on a covered call is possible since the decrease in stock value can cause a decline in your option premiums. You can also have other risks, including buying and selling of fees and other potential losses.