Writing a Covered Call
Writing a covered call is a conservative bullish strategy that has the potential to work when the underlying stock doesn't have volatile price moves. If a stock is a slow mover or is simply moving in a sideways manner, it can be a good candidate for a covered call. Simply stated, writing a covered call on Google would be insane, while using Microsoft for a candidate would make sense. When it comes to covered calls, volatility is bad and boring is good.
Writing a covered call is the same as selling a covered call, as the term sell is synonymous with write. An individual is simply selling a call option on a stock that is owned. The word "covered" means that a stock is owned and will meet an obligation. If you are called out and forced to produce the stock, you can meet the obligation because you are "covered." On the opposite end of the spectrum, if you did not own the stock and were unable to produce it without going out and purchasing it, you would be "naked." Entering naked positions can be a very dangerous proposition.
The purpose of a covered call is to essential "rent" out the stock you own for a month and collect a premium for doing so. Think of the stock you own as an apartment building that you purchased. When you rent out a unit in the apartment you receive a rent payment, but if the unit is unoccupied you receive nothing. The stock in your portfolio is just sitting there and writing a covered call is simply renting it out for the month.
Writing a covered call works like this: You own a stock (or you buy the stock) and sell a call at the next strike price up (out of the money) for the current month or next month. You make money when entering the trade, receiving a premium up front, and you keep the stock unless the price rises to the strike price, in which case you produce the stock for a profit.
Those who want to use a covered call strategy, but don't own the stock, can conduct what's known as a "buy-write," which means they buy the stock and sell the option with one transaction.
