Covered calls are a strategy that involves buying a stock and selling a call option on that same stock. The call option gives the buyer the right, but not the obligation, to purchase the underlying stock at a predetermined price (the strike price) by a certain date (the expiration date). By selling a call option, the seller (also known as the writer) is willing to sell their stock at the strike price and receive a premium for doing so.
Five Reasons Why Covered Calls are Safer and Better Than Buying Stocks:
Reason #1: Ability to Make Money from Time Decay
One advantage of covered calls is the ability to make money from time decay. As the expiration date of the call option approaches, the value of the option decreases (also known as “decaying”). If the stock price remains below the strike price, the seller gets to keep the premium they received for selling the call option, in addition to any potential appreciation in the stock price.
Reason #2: Lower Risk of Entry into a Stock
Covered calls can also lower the risk of entry into a stock. By selling a call option, the seller is capping the potential gain on the stock at the strike price. This can be beneficial in cases where the stock is highly volatile or the seller is not comfortable with the potential for large losses.
Reason #3: Protection on a Position
Covered calls can also be used to protect oneself on a position. If the stock price falls below the strike price, the seller gets to keep the premium and is able to sell their stock at the strike price, limiting their loss.
Reason #4: Potential for Income Generation
In addition to the potential for appreciation in the stock price, covered calls can also generate income through the premium received for selling the call option. This can be an attractive feature for investors looking for ways to generate additional income from their portfolio.
Reason # 5: Spread Risk of a Portfolio
Covered calls can be used to spread the risk of a portfolio by using different strategies. For example, a trader may use covered calls on some positions while also holding other positions outright or using other options strategies. This can help to diversify the portfolio and manage risk.
