Covered Call Writing Strategy

When writing a call option, the writer speculates that the price of the underlying security will go down. In other words, they do not want the option to be exercised.

Writing a covered call is different than writing a simple call (or naked) in the sense that the writer is hedging his position. Say Mr. Writer writes an Apple July 2009 $100 Call Option and Mr. Investor buys that call option. At the same time, Mr. Writer buys Apple Stock at the market price, say $100. Let us assume that the price of Apple went up to $150. In the real world scenario, Mr. Investor will call Mr. Writer and ask him to exercise his option. So now Mr. Writer has to give Mr. Investor 100 shares of Apple at $100.

Mr. Writer is “covered” because he already has Apple shares at $100, so his losses are minimized. He actually ends up making a profit. Mr. Investor also realizes a $50 profit on his exercise.

If Mr. Writer was not covered, then he would have had to buy Apple shares at $150, and sell them to Mr. Writer at $100. His loss would have been $50 per share, yet offset with the money he was paid for the call option by Mr. Investor.

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