What is a covered call?

A covered call is an options strategy whereby an investor holds a long position in a stock or ETF and writes (sells) call options on that same stock or EFT in an attempt to generate increased income from the security. This is often employed when an investor has a short-term neutral view on the security and for this reason holds the security long and simultaneously has a short position via the option to generate income from the option premium.

When writing a call, typically an investor will need at least 100 shares of the stock or EFT for each call option that is written.

For example, let's say that you own shares of the TSJ Sports Conglomerate and like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a few dollars of its current price of, say, $25. If you sell a call option on TSJ for $26.00, you earn the premium from the option sale but cap your upside. One of three scenarios is likely to play out:

a) TSJ shares trade flat (below the $26 strike price) - the option will expire worthless and you keep the premium from the option. In this case, by using the covered call strategy you have successfully outperformed the stock.

b) TSJ shares fall - the option expires worthless, you keep the premium, and again you outperform the stock.

c) TSJ shares rise above $26 - the option is exercised, and your upside is capped at $26, plus the option premium. In this case, if the stock price goes higher than $26, plus the premium, your covered call strategy has underperformed the TSJ shares.

Find out more details about the covered call options strategy.

Please note: Options involve risk and are not suitable for all investors. Before investing in options, please read the Characteristics and Risks of Standardized Options.