A covered calls strategy is a limited risk strategy that is utilized by veteran and beginner traders, alike. It provides excellent benefits to both the buyer and the seller of the stock. Basically, covered call options provide buyers the opportunity to buy a stock at a predetermined price on or before a preset date. The buyer is not obligated to buy the stock once the option expiration lapses, especially if the stock price goes even further in the future. However, he or she can buy the stock if the prices continue to rise, which makes the arrangement a great investment considering the buyer bought the stock at a lower price.
Stockholders who enter into covered call contracts have various reasons to do so. For starters, these stockholders want to earn extra income from the premium that occurs when another trader enters into a covered call contract with them. The stockholders often believe that the prices of the stocks they are holding won't change significantly in the near future, so the best way for them to maximize their earning potential is to create a covered call agreement. Aside from generating extra income from the premium, the stockholder who sells a stock in a covered call arrangement has the opportunity to keep the stock if the buyer does not proceed with the purchase of the stock once the option expiration lapses.
However, stockholders who enter into covered call contracts are also suppressing the value of their stocks. These stockholders are risking the probability that the stocks they own will become more valuable in the future. For instance, if a stockholder who sells a stock for a strike price of $40 is basically saying the said stock's price won't be more than $40 after the expiration, thus he could lose out on additional money in case the price rises to $45 or higher after the deal expires.
On the other hand, traders and investors who enter into covered call contracts usually believe that the stocks they are interested in will increase in value after the option expiration lapses. These traders are no fortunetellers, but they usually foresee the stocks they are acquiring through a covered call arrangement will shoot up in prices in the future.
Entering into covered call options is one of the many investment strategies that equity traders employ. New investors who want to know more about covered calls can find more information at barchart.com, a leading financial market information provider.
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