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Welcome to Professor Savings
We teach finance basics
Hi I’m your host today Rayfil Wong
today’s topic,
“What is a covered call?”
Writing A Covered Call is the process of selling to a buyer, The right to buy a stock at given price in near future.
Also known as “Shorting”
A simple way to explain this concept.
Imagine writing options is similar to issuing an insurance policy.
An insurance company offers to insure property, it demands a premium in exchange for assuming risks.
The higher the risk presented, the higher the premium charged to the client.
Just common sense.
so
the fee that the option seller collects is known as a premium.
Let’s say Jane
believes Bob’s dogtoy.com will hover around its current trading price of $100 a share. She decides to write one call option with the $105 strike price and collects a $3 premium.
She also holds 100 shares of Dogtoy.com, which she had previously purchased for $100 per share. If the price jumps to $105 the buyer exercise the option to buy $105 per share.
Exercising the option, places an obligation on Jane to sell at that price.
For total gain from writing this call option is $800, which is the $300 premium received and a capital gain of $500 the resulted from selling her $100 shares for $105. Because Jane owns the unrelying stock of the company, she is using what is known as “Covered Call”.
$100
$105 strike price
$ 3 premium
_
100 shares
100 x 100 (stock price) = $10,000
100 x 105 (strike price) = $10,500
_
total gain
$3 premium x 100 shares = $300
10,500 – 10,000 = $500
$300 + $500 = $800
_
People use covered call since
cut down option risk
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