Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 33

Shorty Heaven: Selling Your Way to Profits

“Okay,now let’s turn our attention to the covered call,”said Aaron.

“In this trade, I own stock and I add a short call to it. That’s the combination. I add the short call because it allows me to take in a credit—I can make money on my stock without doing anything. This is what Shorty discovered on his own about short calls.” (See Figure 33.1.)

“This is referred to as a covered call,” he continued, “because we own the stock, and we can think of the stock we own as ‘covering’ the short call we’re placing. As we mentioned earlier, if we didn’t own the stock, then—through our short call—we would be entering an obligation to sell shares we don’t own precisely when the cost of the stock is higher than our strike price—meaning, again, that we would have to go out on the market to buy shares at the higher market price so we could turn around and meet our obligation to sell them at the lower strike price we agreed to. That guarantees a loss.”

I add the short call because it allows me to take in a credit—I can make money on my stock without doing anything.

“Right,” added Nate, “which is precisely why we never do such naked calls. In fact, unless you meet certain conditions, your broker won’t let you. But still, that’s what it’s called—a naked call—and what we’re going to talk about is called a covered call to distinguish it from this dangerous version.”

FIGURE 33.1 The Covered Call

“Now to be a bit simplistic, basically two things can ...