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Covered Call Explained

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Covered call is very popular among the high net worth individuals who buy shares for the long term. These people take benefit of covered call to make money every month. Covered calls are very poplar in US where high net traders are many.

What Is Covered Call

Covered Call is a method to sell shares in a future date with no obligation to buy back if certain conditions are not met.

When you own a stock you have the right to sell anytime at market price or in future at a higher price using options. Covered call is selling the stock to someone else at a higher price in a future date for an agreed money as shown in in system. This money varies from stock to stock and price to price.

Basically when a covered call is done the owner of the stock sells the stock to someone else at a agreed price to get cash today. This is done at a higher price than the current price of the stock. This means that the owner of the stock gives the buyer of the option the right to buy his shares before the option expires, at a predetermined price, called the strike price.

Now What May Happen In Expiry

If the stock does not reach the predetermined price or the strike price which the owner sold the stock for, the Call Option expires worthless and the owner of the stock keeps the money he got to sell the stock at date price.

If the stock reaches the predetermined price or the strike price which the owner sold the stock for, the Call Option becomes In The Money (ITM). In this case since the sell price is lower than the buy price the owner have to take the loss on the option sold, but can cover the loss by selling the shares he owned.

Most of the times the sold options expire worthless so the owner of the stock keeps the money he got while selling the call. Otherwise they can always sell the stock to cover the loss.

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{ 2 comments… add one }
  • Hemant

    Thanks for the post on Covered Calls. My understanding is that covered call is not a strategy that can be used in India. If you sell a call on the stock owned by you, your stock will not be called away automatically, if it is ‘In the Money’ at expiration. Please let me know if my understanding is correct. In India, the covered calls you sell have to be bought back at a loss, if they are In the Money at expiration.

    Thanks for your fantastic service


    • Yes in India options are cash settled. The owner of the stock need not give his stocks to the buyer.

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