For those who are not too familiar with common trading jargon, you may not readily understand the concept of the covered call strategy and its function in trading activity. To shed some light on it, basically, it’s a low-risk strategy where an investor or trader holds a long-term position in an asset and writes/sells call options on that particular asset in hopes of generating a bigger income from it.
However, like all strategies for trading and investments, using covered calls has both benefits and risks. It’s imperative to know what they are so you can take a step back and analyse your trading situation before applying this strategy.
The most important advantage is that compared to all the other known low-risk strategies out there, it’s said that becoming an expert at covered call writing can secure the highest profit – much, much higher than if other strategies were used. Everybody’s into trading to harness wealth, so this advantage is surely the most attractive.
The second benefit covered calls offer is the way traders actually have more control over the outcome. Writing a call allows traders to really examine the conditions their stocks are dealing with and determine the best decisions on what should be done, say, if the stock’s value declines after the traders have entered a position, or if the price of the stock appreciates. The trader who has mastered covered call writing has that great opportunity to fortify his wins and mitigate losses.
As for the risks or disadvantages, profit potential, when investors have established a covered call position, is automatically limited to the strike price (the price at which a put or call option can be exercised). So, if you were too hasty in writing a $70 call on a stock that you originally purchased at $65, and due to an unexpected twist of events the market dictated that that the new value of the stock is already up at $85, you have no other option but to sell at the price that you have written. Instead of a $20 profit, you limited yours to a mere $5.
And the second risk is that due to the simplicity of the move, a lot of investors are easily convinced that they already know everything that needs to be considered in employing covered calls, only to realise that they’ve traded too soon. It takes at least three to four months to fully explore the capabilities and potential of this strategy.
Therefore, for those who want to use covered calls to help themselves reach an advantageous position as traders or investors, it’s crucial to get some mastery in it. This is possible through persistent study, practice, and proper coaching from respected names in the trading industry. In time, they can truly expect to make the strategy work optimally for them in securing trading success.