Writing a covered call means you are selling someone else the right to purchase a stock that you already own, at a pre-determined price, within a stipulated time frame. As a hedge, your maximum upside is the value of the option.
According to Mark Wolfinger, author of The Rookie's Guide to Options, "When writing covered calls, stock selection is the single most important factor in determining your success or failure."
The absence of downside protection makes this unsuitable for novice investors.
With the value of the option representing the maximum profit potential, this strategy is limited.
Low to Moderate
Instead of spending money, you get upfront cash. However, you could miss out on an upward market.
An investor buys XYZ stock for $50 per share. They believe it will rise to $60 by the end of the year. However, to be safe, if it hits $55 within six months, they will sell.
Since risk has a time element, selling a covered call on this position could protect the downside. For example, selling a $55 six-month call option brings in $4 per share premium. That is cash paid to the stock owner. In return, the buyer has the right to buy these shares for $55 within six months, regardless of their value.
The investor keeps the $4 premium plus the $55 from the share sale, for a total of $59, or an 18% return. The downside occurs if the stock prices go higher.
© 2020 Todd Moses
The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.