A covered call is an options trading strategy where an investor takes a long position in a security and sells call options on that same security to generate investment income. It is a conservative options strategy used to reduce the unlimited risk associated with naked or uncovered calls.
Stock owners are entitled to an assortment of rights, including the right to sell held stock at any time for the associated market price. A covered call is the act of executing this right to another investor for cash. The writer or seller of the covered call sells the buyer of the covered call the right to purchase his shares before the underlying call expires at the predetermined strike price.
For the right to purchase the shares at a predetermined price, the buyer of the covered call pays the seller a premium. The premium is paid for in cash to the writer or seller of the covered call the day the option is sold. A seller of a covered call receives cash the same day in exchange for the underlying security’s future upside.
Selling a covered call helps mitigate the risks associated with uncovered calls, while adding immediate cash returns. The sale also caps the writer’s investment upside. The seller loses out on potential gains if the underlying security’s price rises above the strike price at the time of expiration.