A covered call option trading strategy is a strategy where you sell a call option against shares that you already own. For instance, let’s assume you held 100 shares in company xyz and your outlook for these shares was that they may increase a little or decrease a little over the next say 3 months.
Rather than selling the shares and looking for a stock that you hope will increase in value at a greater rate, you could implement a covered call strategy.
So, taking the above scenario as an example, you could write a covered call, x number of strike prices above the current price of the stock.
Let’s have a look at a few possible outcomes, assuming that you received $ 100 in premium for writing the call.
A. The stock increases in price a little over the next 3 months, but does not hit the strike price at which you wrote the call. Here you have gained 2 fold, as you benefit from the increase in stock price and you get to keep the $ 100, as the call has expired worthless.
B. The stock falls in price a little over the next 3 months. Here, you have lost money on the stock as it has fallen, however, this loss is offset by the $ 100 that you received for writing the call. It is possible that the $ 100 could cover all of the loss, or maybe even still generate a profit if the loss on the stock is less than $ 100.
C. The stock increases in price over the next 3 months and trades over the strike price at which you wrote the call. Here you benefit to a limited degree, as the profits generated from this move are limited, with no extra profits being generated above the strike price of the call.
The covered call options trading strategy is considered to be conservative in nature, it can be used if a person is looking for greater profits out of a slow / range bound stock, it can be used to purchase a stock at a lower price than it is actually trading at, it can be used as a hedge against potential losses, Etc, Etc.
A very profitable long term trading system can be built around the implementation of the covered call strategy.
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