A covered call is an options strategy that is used to generate income. This income comes from the call premium that is paid by the buyer to the seller. The holder of the underlying security sells an options contract to the buyer, who then pays the seller a call premium in exchange for the right to buy the underlying security at a specified price and date in the future. Typically, a longer option period benefits the buyer and a shorter option period benefits the seller. A covered call is considered “covered” because the seller of the options contract owns the stock and can “cover” the position by delivering the shares to the buyer if they call the shares away.
Example: I own 100 shares of stock that is currently trading at $85 per share. I sell you a covered call option on those 100 shares for a call premium of $5 per share. You, the buyer of the options contract, pay me $500 in call premium to have the right to buy my shares at $95 per share. If the stock gets to $105 per share, you are likely to buy my shares from me because you only have to pay $100 per share ($5 call premium that you already paid + $95 per share contract price). On the contrary, if the stock drops to $75 per share, our options contract will likely expire worthless, and I will keep my 100 shares of stock and the $5 per share call premium.
