Investment Type: Credit
Strike Prices: ITM/ATM/OTM
Expiration Month: No restriction
Composition: Buy Stock + Sell Call

Covered call is a popular strategy among traders. It consists of buying the stock itself and selling call. In this case the sell call portion is not considered naked anymore as we have covered it with the stock. The best analogy for covered call is similar to buy a property and rent it out while the asset is appreciating as the time goes. In covered call, we can Sell Call with current month expiration or later month as well. This is the flexibility that is not available with property. However, stocks are much more volatile than property,

therefore it’s best to perform covered call on less volatile stocks.

We buy the stock and we got extra income by selling OTM call to collect premiums every month (every bi-monthly, every quarter, etc.). When the stock price goes down, we literally have a “cushion” that lowers our breakeven point, which is basically the premium that we received every month. On the other hand, if the stock price goes up too fast and rises beyond the strike price of the call, we might get exercised. At that time we have to sell our stock (which we have bought before) and make profit from the difference.

The only drawback in covered call is when the stock price goes down too much beyond the breakeven point, we will have unlimited risk. Also, it’s an expensive strategy as we have to buy the stock. However, if we can successfully collect premium so that the amounts exceed our initial investment in the stock, eventually we own the stock for free.