What is Covered Call?

An options strategy whereby an investor holds a long position in an asset and writes (sells) call options on that same asset in an attempt to generate increased income from the asset. This is often employed when an investor has a short-term neutral to bullish view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium.

For example, let’s say that you own shares of the ITC Conglomerate and like its long-term prospects as well as its share price but feel in the shorter term the stock will likely trade relatively flat, perhaps within a tens of rupees from its current price of, say,257. If you sell a call option on ITC for 280, you earn the premium from the option sale but cap your upside. One of three scenarios is going to play out:

a) ITC shares trade flat (below the 280 strike price) – the option will expire worthless and you keep the premium from the option. In this case, by using the buy-write strategy you have successfully outperformed the stock.

b) ITC shares fall – the option expires worthless, you keep the premium, and again you outperform the stock.

c) ITC shares rise above 280 – the option is exercised, and your upside is capped at 280, plus the option premium. In this case, if the stock price goes higher than 280, plus the premium, your Covered call strategy will turn into profit booking at 280 plus premium.

Keep in Mind….

1. Must to hold the stock with quantity matching the lot size, before initiating a Covered Call.

2. If the stock goes up above the far away Strike price, then pay-off will be as good as selling the stock at the strike price plus premium.

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