A Covered Call is a strategy wherein the investor enters a long position in the underlying security and simultaneously sells call options of the same underlying.
The investor can use this strategy to generate income by selling call options and earn a premium while still retaining the ownership of the underlying security.
This strategy is also referred to as ‘Synthetic Short Put’.
When to use this strategy?
Such a strategy is entered into when the investor is bullish on the underlying security for the long term but has a short term bearish view on the asset.
How to build this strategy?
This strategy has two legs:
Leg 1 – Buy the underlying security, quantity being equivalent to the lot size of the option contract.
Leg 2 – Sell 1 Call
Credit Spread/Debit Spread
This is a debit spread strategy.
The profit potential is limited in this strategy.
When is this strategy profitable?
The maximum profit is achieved when the underlying security’s price reaches the strike price of the call option.
The investor faces unlimited risk in this strategy.
However, the investor in this strategy has a cushion to the tune of the premium received for selling the call option.
When is this strategy unprofitable?
Investors in this strategy face the same risk as that which the typical stockowners are exposed to.