The Covered Call Writing setup is created when you sell (“write” or “short”) a call against an established position or a new position in the underlying stock. This position creates a net credit. It is an opportunity for you to create additional income as a result of the premium you receive and increase the overall return on the stock. It also provides you with some downside protection in the event that the price of the stock falls.
Setup Mechanics Description:
Covered calls setups work best in a neutral market or if you have a slight-to-moderate bullish outlook. The position takes advantage of a neutral or potentially bullish market, where the time decay of the short call will cause it to expire worthless.
Covered call writing looks to profit when the outlook on a stock isn’t particularly bullish. It is considered one of the safest option setup and one of the earliest trading permissions that that broker would give when a trader is looking to get started with options.
The increased returns in a slightly bullish to neutral environment come with a trade-off. You must be willing to sell the stock at the strike price even if the stock continues to appreciate in a strong bull market. Should an exercise take place before the expiration of the short call, you will need to sell your stock at the strike price. The strike price (higher than the original purchase price of the stock) establishes the sale price of the stock, locking in its future value for the person who holds the call option you sold.