6 The Basic Covered Call

The most popular option hedge is the covered call. This in its most basic form has two parts: 100 shares of stock held in your portfolio, offset by a short call. If that call is exercised, you are required to give up 100 shares at the fixed strike, even if the current market value is higher. At the time you open the covered call, you receive the call premium and it is yours to keep, whether the call is exercised, expires worthless, or is later closed.

This is the starting point for developing a hedging strategy. The premium you receive for selling the call reduces your net basis in stock and creates a downside cushion. When you own 100 shares of stock, your market risk level is any price below your cost. With a covered ...

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