In a covered call writing strategy, an investor attempts to generate extra income by writing (selling) call options on an owned stock. If, at option expiration, the stock price is below the strike price of the option, then the option is “out-of-the-money” and the investor keeps the premium. If, at option expiration, the stock price is above the strike price of the option, then the option is “in-the-money” and the investor’s stock is “called away” or sold. This strategy is the most basic and most widely used options strategy, combining the flexibility of options with stock ownership.
Though the covered call can be utilized in any market condition, it is most often employed when the investor, while bullish on the underlying stock, feels that its market value will experience little range over the lifetime of the call contract. The investor desires to either generate additional income (over dividends) from shares of the underlying stock, and/or provide a limited amount of protection against a decline in underlying stock value.1
While this strategy can offer limited protection from a decline in price of the underlying stock and limited profit participation with an increase in stock price, it generates income because the investor keeps the premium received from writing the call. At the same time, the investor can appreciate all benefits of underlying stock ownership, such as dividends and voting rights, unless he is assigned an exercise notice on the written call and is obligated to sell his shares. The covered call is widely regarded as a conservative strategy because it decreases the risk of stock ownership.2
Flying Point Asset Management LLC employs a covered call writing strategy on several positions. In the event an option expires “in-the-money”, rather than selling the stock, the firm usually buys back the existing option and simultaneously sells an option of a different strike price and/or a different expiration date. By not selling the stock, the investor avoids realizing a taxable capital gain.
1 The Options Industry Council Website: Options Strategies: Covered Call
2 Ibid