The Covered Call is a crucial strategy in the realm of investment options. It involves selling calls on stocks or ETFs, using these stocks as collateral. This strategy yields additional income and provides a certain level of hedging against minor market declines.
Simply put, a Covered Call entails purchasing stocks and selling calls on those stocks. Since the standard option size is 100, the number of shares bought must be in multiples of 100. Apart from utilizing stocks as the core of the strategy, there are also variants that incorporate LEAP-type financial options or synthetic underlying assets.
The maximum profit of the Covered Call is achieved when the price reaches the strike of the Call sold. Beyond that point, the strategy no longer enhances the profit, even if the stock price continues to rise. While the maximum risk is often termed as unlimited, it is substantial, as the stock cannot fall below zero. For more details.
The Covered Call strategy serves as both a hedging and income-generating approach. The delta, measuring the sensitivity of the option price to the underlying’s price, and the theta, gauging how the option’s value changes over time, are two critical Greeks to consider in this strategy. The delta of a Covered Call is positive but lower than holding just the stock, thus mitigating price exposure.
This strategy is most effective in stocks or ETFs exhibiting a sideways or upward sideways trend. It is worth noting that the Short Call provides a partial hedge, but this hedge diminishes as the stock price declines.
Moreover, the Covered Call is contrasted with earning dividends, underscoring that the sale of Calls on stocks can result in more favorable returns. However, a significant limitation is that profits are capped at the Short Call strike.
The advantages of the Covered Call include generating recurring income and providing a partial hedge during price pullbacks. Nevertheless, it has limitations, such as restricted profits in an uptrend and a partial hedge that weakens in downtrends.
In conclusion, the Covered Call offers diverse applications that blend income generation and partial hedging. It underscores the importance of hedging strategies in investing to mitigate substantial losses during market declines.
José Luis Díaz.
