The covered call: stock plus a short call, or a short put. The term covered means that the stock covers the inherent obligation assumed in writing the call. Why would you write a covered call? You feel the stock’s price will not go up any time soon, and you want to increase your income by collecting some call option premiums. To add some insurance that the stock won’t get called away, the call writer can write out-of-the money calls. You should know that this strategy for enhancing one’s income is not without risk. The call writer is trading the stock’s upside potential for the call premium. The desirability of writing a covered call to enhance income depends upon the chance that the stock price will exceed the exercise price at which the trader writes the call. The owner of a stock has the rights to all upside potential. The profits for a short call are limited to the premium.
For example, say that a stock owner writes a covered call at a stock price (S) of $50 and an exercise price (X) of $55 for a premium of $4. If at expiration, the price of the stock is more than $50 but less than $55, the buyer will not exercise, and the writer will "gain" the premium plus any stock appreciation between $50 and $55. If at expiration, the price of the stock is more than $55, the buyer will exercise for $55 and the writer's gain is limited to the premium plus the appreciation from $50 to $55.
