A covered call is a financial investment strategy where investors sell call options on securities they already own. It gives the buyer of the call option the right to purchase the underlying security at a predetermined price (the strike price) during a specific period without any obligation. If the stock doesn’t reach the strike price before expiration, the option expires, and the seller can keep the premium received from writing the call. Look here for more information on this.
You can use covered calls in Australia to generate income from securities you already own if you own 100 shares of Company X that are currently trading at $50 per share. You could sell a call option with a strike price of $55 for $2 per share. It will give the buyer the right to buy your stock from you for $55 at any time before expiration, but they would not be required to do so.
If Company X’s share price fell below $55 after you sold the call option, then it wouldn’t make sense for them to use their option. The option would expire, and you would keep what you received as a premium from selling it. If the shares increase in value over time, its owner might eventually exercise the call option when it reaches expiration. In this case, if Company X shares were trading at $100 per share when the call was exercised, then the buyer would purchase your 100 shares for $55 each ($5 500 total), which is still a profit of $1,500 from when you originally bought the shares.
Selling Uncovered Calls is Equivalent to Short-Selling
When you sell an uncovered call, the option’s strike price is above the current market value of your securities (in our example, XYZ Company’s share price is currently $50). Due to this, it would be perilous for you if traders purchased 100 shares of Company X at $55 each ($5 500 total) during expiration.
Time Decay Benefits the Seller When They Are Selling Options
The longer an option has until expiration, the more likely it is for the price of that option to increase. Options with longer durations effectively are more likely to be exercised, so their premiums increase accordingly. When selling covered calls, time decay benefits you because you sell options with shorter durations and keep them open for less time than if someone purchased your stock using the call option you sold.
Collect Premiums On an Ongoing Basis
As long as the underlying security does not reach its strike price within the life of your option contract (the duration), then you can continue to collect premiums on an ongoing regular basis. Receiving these extra cash flows depends on how often new option contracts are written and purchased.
Sell Your Stock at the Strike Price if the Option is Exercised
When you sell a covered call, you are giving someone else the right, but not the obligation, to purchase your underlying security at a predetermined price. If the option is exercised by its buyer, you are obligated to sell your securities at the strike price. It can be good or bad, depending on how close the strike price is to the current market value of your security.
Using Options Contracts to Limit Your Downside Risk
If you’re worried that XYZ Company’s share price might decrease in value after you’ve sold a call option, you could use an option contract to limit your downside risk. For example, you could sell a $55 call option but buy a $50 put option for insurance. If XYZ Company shares did fall below $50 after you sold the first option, then the second option would protect your purchase price to an extent. When you combine two option positions with opposing characteristics (i.e., one gives its buyer the right to purchase your security at a higher price while another gives its buyer the right to sell it back at a lower price).
