What is a Covered Call?

Investors who want to minimize the risk involved with trading stocks may want to understand what a covered call is. A covered call is a sort of options strategy that can actually be both profitable and hedge your long position simultaneously.

To use a covered call option, investors need to be the stock owner, with a minimum of 100 shares. They must have the right to buy and sell this underlying stock at a specific fixed price (or strike price) within a set time frame.

Investors typically implement this strategy when a stock has profited and may likely get a pullback in the short term. Instead of selling stock to bypass the downturn, investors can sell their call options against the underlying as a sort of hedge.

When investors sell options, they receive a premium that they’ll get to keep providing the option expires when out of the money. As a call option seller, you want the underlying price to stay below the strike price during expiration. This allows you to keep the premium. If an underlying expires just one cent or more above the strike price, then your options are assigned, and you’ll have to sell the stock at the strike price.

Pros and Cons Of Covered Calls

One of the biggest draws of covered calls is that traders can protect their long position while simultaneously making money. There are some negatives from covered calls, however.

One of the biggest drawbacks is that it doesn’t protect you in a significant sell-off since a call option is only worth a certain amount and can’t make up for how much you might lose if the stock dives. Another difficulty is that covered calls only protect you for a set time since options are expiring assets.