Writing Covered Calls
Writing Covered Calls
You would have probably heard by now that there is more than one way to earn and profit from stocks. One of these ways is through stock options. In general there are two kinds of stock options. The call stock options and put stock option. In calls, the writer of the call is required to sell the underlying stock at a given price when the holder of the stock option chooses to exercise the option. In put stock option, the writer of the put is required to buy the underlying stock at a given price when the holder chooses to exercise the put stock option. In writing calls, there are two kinds of writers: the covered call writer and the uncovered call writer. A covered call writer writes a call stock option in which he owns the underlying stock that is subject of the call stock option whereas in an uncovered call option or naked stock option, the writer of the call does not own the stocks that are the subject matter of the stock option.
To better understand how covered call stock options work, here is a simple illustration. Assuming that investor I owns 10,000 shares of stock S valued at the fair market value of $50 per share. Investor I wants to earn some cash from the 10,000 shares of stock that he owns, hence he decides to sell a covered call stock option. For a premium or consideration of $0.03 per stock, investor I is willing to sell 10 covered call stock option (which has 100 shares each) wherein the strike price or option price is at the current fair market value of $50 per share and it can be exercised anytime within the next three months. This means that if investor N decides to purchase 10 call stock option for 10,000 shares of stock S he would pay investor I the total premium of $300 and he can exercise the call within the next three months. When you say ‘exercise’ this means that investor N can buy the 10,000 shares of stock S for only $50 each, regardless of the actual market value at the time of the exercise. This means that for $300 investor I is promising to sell his 10,000 shares of stock S for $50 each to investor N within the next three months. Investor N may or may not want to exercise the call stock option but he can if he wants to.
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