Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management

Chapter 10. The Buy-Write, or the Covered Call

The covered call strategy naturally extends from buying common stock. Using covered calls offers thepossibility for immediate income and tends to be a safe investment, from the perspective of both a brokerage house and the investor whois eager to generate additional income for his portfolio. Thus, the covered call is a popular strategy for the individualinvestor. The concept is also easy to explain. Even so, it is one of the most misunderstood and perhaps overused option tactics available.

The Buy-Write (Covered Call) Defined

In its most basic form, an investor who owns (long) stock sells (writes) a near–at-the-money call or slightly out-of-the-money call. This strategy is called covered if the investor writes enough call options to cover the stock position (usually one option contract equals one hundred shares of stock). For example, if an investor owns one thousand shares of stock, he or she will write ten call options to cover those thousand shares. If the party who buys the call contracts exercises them, requiring the original investor to sell the thousand shares underlying the options, the investor has the shares in hand to complete the trade.

Although the terms buy-write and covered call are often used synonymously, they differ in implementation. Generally speaking, a covered call applies to an investor who simply sells call option contracts against his existing long stock position. Buy-write applies when the investor buys the underlying ...