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Intro to Covered Calls

Intro to Covered Calls
Written by
Max Andrews
Max Andrews
Published on
February 28, 2024
Read time
3
 min read

Intro to Covered Calls

Ladies and Gents,

Who wouldn’t want to make some income from options? Is that even possible?

Let’s dive in…

Covered Calls 🎯

One of the best ways to generate “income” from options is to sell call and put contracts. As we know from our options series (check out past articles here), when you buy an option you pay the “premium” for the right to buy or sell the stock at a certain price up to a specific date.

So if we flipped places (became the seller) and “sold the option” we get the premium.

⭐ Reminder - The seller of an option gets the premium regardless if the option expires worthless or not.

⭐ Example - If you own 100 shares of Apple stock (options are traded in blocks of 100 shares by the way) and you want to generate some income, you could sell a “Covered Call”.

If you (as the seller) sold an Apple call option (to the buyer), you are selling the right for the buyer to buy Apple from you at a certain price, lets say $100.

Well, this could be risky if you had to “deliver” (aka sell) the stock in the event that the dude who bought your call option decides to execute his “right to buy”.

Good news, you are covered. (Hence, “Covered Calls”). Since you already own the stock, you don’t have to go buy it, then “deliver” it to him.

⭐ Example - If Apple’s price goes to $150 and the strike price was $100 - the guy who bought your option will execute his “right to buy” 100 shares for $100 (even though the stock is at $150), but, since you are “covered” (as opposed to “Naked”, yes, these are the literal terms) - you will simply sell 100 shares for $100 strike price.

🎯If you realized that it is important to have previously purchased the shares for less than you are willing to sell them, you would be correct. Who would want to be forced to sell 100 shares for $100 if you previously bought the shares for $120 (that’s a -$20 loss per share).

Covered Call strategies work well when:

- The strike price is above what you paid for the stock.

- If you are already holding shares and want to collect a little premium.

Summary ✅

- A call is “covered” if you already own the shares you may have to sell.

- If you sell a covered call, you collect the premium up front.

This is one of the more difficult concepts in finance, so don’t sweat it chief. We will keep working our way through these concepts, so stay tuned. Again, not financial advice…

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