A covered option is a financial transaction in which the holder of

securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...

sells (or "writes") a type of financial options contract known as a "

call Call or Calls may refer to: Arts, entertainment, and media Games * Call, a type of betting in poker * Call, in the game of contract bridge, a bid, pass, double, or redouble in the bidding stage Music and dance * Call (band), from Lahore, Paki ...

" or a " put" against stock that they own or are shorting. The seller of a covered option receives compensation, or "premium", for this transaction, which can limit losses; however, the act of selling a covered option also limits their profit potential to the upside. One covered option is sold for every hundred shares the seller wishes to cover. A covered option constructed with a call is called a "covered call", while one constructed with a put is a "covered put". This strategy is generally considered conservative because the seller of a covered option reduces both their risk and their return.

Characteristics

Covered calls are bullish by nature, while covered puts are bearish. The payoff from selling a covered call is identical to selling a short

naked put A naked option or uncovered option is an options contract where the option writer (i.e., the seller) does not hold the underlying security position to cover the contract in case of assignment (like in a covered option). Nor does the seller hold ...

. Both variants are a short

implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equ ...

strategy. Covered calls can be sold at various levels of

moneyness In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...

. Out-of-the-money covered calls have a higher potential for profit, but also protect against less risk, as compared to in-the-money covered calls.

References

Bibliography

* Brill, Maria. "Options for Generating Income." Financial Advisor. (July 2006) pp. 85–86. * Calio, Vince. Covered Calls Become Another Alpha Source." Pensions & Investments. (May 1, 2006). * "Covered Call Strategy Could Have Helped, Study Shows" Pensions & Investments, Sept. 20, 2004, p. 38. * Crawford, Gregory. "Buy Writing Makes Comeback as Way to Hedge Risk." Pensions & Investments. May 16, 2005. * Demby, Elayne Robertson. "Maintaining Speed -- In a Sideways or Falling Market, Writing Covered Call Options Is One Way To Give Your Clients Some Traction." Bloomberg Wealth Manager, February 2005. * Feldman, Barry, and Dhruv Roy
"Passive Options-Based Investment Strategies: The Case of the CBOE S&P 500 BuyWrite Index.
''

The Journal of Investing ''The Journal of Investing'' is a quarterly peer-reviewed academic journal that covers research on investment management, asset allocation, performance measurement, benchmarking, mutual funds, investing strategies such as 130/30 funds, global alloc ...

'' . (Summer 2005). * Frankel, Doris. "Buy-writes Catch on in Sideways U.S. Stock Market." Reuters. (Jun 17, 2005). * Fulton, Benjamin T., and Matthew T. Moran. "BuyWrite Benchmark Indexes and the First Options-Based ETFs" Institutional Investor—A Guide to ETFs and Indexing Innovations (Fall 2008), pp. 101–110. * Szado, Edward, and

Thomas Schneeweis Thomas Schneeweis, professor of finance at the School of Management, University of Massachusetts Amherst, Amherst, MA, is also the director of the Center for International Securities and Derivatives Markets there. He is president of Alternativ ...

QQ_Active_Collar_Paper_website_v3 "Loosening Your Collar: Alternative Implementations of QQQ Collars.
CISDM, Isenberg School of Management, University of Massachusetts, Amherst. (Original Version: August 2009. Current Update: September 2009). * Kapadia, Nikunj, and Edward Szado
"The Risk and Return Characteristics of the Buy-Write Strategy on the Russell 2000 Index.
The Journal of Alternative Investments. (Spring 2007). pp. 39–56. * Renicker, Ryan, Devapriya Mallick
"Enhanced Call Overwriting.
Lehman Brothers Equity Derivatives Strategy. (Nov 17, 2005). * Tan, Kopin

Barron's: The Striking Price. (Nov 28, 2005). * Tan, Kopin
"More Bang, Less Buck. Selling Call Options.
Barron's, SmartMoney. (Dec. 2, 2005). * Hill, Joanne, Venkatesh Balasubramanian, Krag (Buzz) Gregory, and Ingrid Tierens
"Finding Alpha via Covered Index Writing.
Financial Analysts Journal. (Sept.-Oct. 2006). pp. 29-46. *Lauricella, Tom. "'Buy Write' Funds May Well Be The Right Strategy." Wall Street Journal. (Sep 8, 2008). pg. R1. * Moran, Matthew

" The Journal of Indexes. (Fourth Quarter, 2002) pp. 34 – 40. * Schneeweis, Thomas, and Richard Spurgin. "The Benefits of Index Option-Based Strategies for Institutional Portfolios" The Journal of Alternative Investments, Spring 2001, pp. 44 – 52. * Tan, Kopin. "Covered Calls Grow in Popularity as Stock Indexes Remain Sluggish." ''

The Wall Street Journal ''The Wall Street Journal'' is an American business-focused, international daily newspaper based in New York City, with international editions also available in Chinese and Japanese. The ''Journal'', along with its Asian editions, is published ...

'', April 12, 2002. * Tergesen, Anne. "Taking Cover with Covered Calls." Business Week, May 21, 2001, p. 132. * Tracy, Tennille. "'Buy-Write' Is Looking Attractive." ''The Wall Street Journal''. (Dec 1, 2008). pg. C6. * Whaley, Robert
"Risk and Return of the CBOE BuyWrite Monthly Index.
The Journal of Derivatives (Winter 2002) pp. 35 – 42. {{Derivatives market Options (finance) Technical analysis

Characteristics

See also

References

Bibliography