Covered option

A covered option is a financial transaction in which the holder of securities sells (or "writes") a type of financial options contract known as a "call" or a "put" against stock that they own or are shorting. The seller of a covered option receives compensation, or "premium", for this transaction, which can limit losses; however, the act of selling a covered option also limits their profit potential to the upside. One covered option is sold for every hundred shares the seller wishes to cover.[1][2]

Payoffs from a short put position, equivalent to that of a covered call
Payoffs from a short call position, equivalent to that of a covered put

A covered option constructed with a call is called a "covered call", while one constructed with a put is a "covered put".[1][2] This strategy is generally considered conservative because the seller of a covered option reduces both their risk and their return.[1]

Characteristics

Covered calls are bullish by nature, while covered puts are bearish.[1][2] The payoff from selling a covered call is identical to selling a short naked put.[3] Both variants are a short implied volatility strategy.[4]

Covered calls can be sold at various levels of moneyness. Out-of-the-money covered calls have a higher potential for profit, but also protect against less risk, as compared to in-the-money covered calls.[1]

See also

References
  1. MacMillan, Lawrence (2002). Options as a strategic investment (4th ed.). New York Institute of Finance. ISBN 978-0735202382.
  2. Butler, Mike (2 February 2016). "Trading Strategy Covered Put". Tastytrade. Retrieved 10 April 2022.
  3. Natenberg, Sheldon (1994). Option volatility and pricing: advanced trading strategies and techniques (1st ed.). McGraw Hill. pp. 260–263.
  4. Zeng, Kai; Schultz, Jim (29 September 2021). "Covered Calls & Poor Man's Covered Calls". Tastytrade. Retrieved 10 April 2022.

Bibliography


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