Covered Calls

Written by Michael Federico
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Covered calls are considered to be one of the safest option positions a person can have. A covered call means that a person combines a long position and a short call option position on the same asset. In essence, a person is selling a call against shares he already has.

If a person has a stock he wants to sell, he can write a call against it. He can then get the amount of the option premium from the person who buys the option contract. For instance, a person who writes a call on shares with a premium of $2 would be paid $2 for selling each share. Calls are generally in terms of 100 shares, so he would basically (there are fees involved) pick up an extra $200.

When Do Covered Calls Work?

When first learning about covered calls, they can seem like a no-brainer. However, it is not always a good idea to write a call. Covered calls are most beneficial for stocks that do not experience large shifts either up or down. If a stock stays relatively consistent, a covered call will allow a person to collect premiums.

If a person expects a stock price to soar, he should not write a call, because he would be missing out on the option to sell at a much higher price. Many people jump into covered calls without looking at the long-term. It is important to have a good grasp on the stock involved in the call. Of course, there will always be surprises on the stock market, but some "surprises" can be avoided with solid research.

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