Payoffs from a short put position, equivalent to that of a covered callPayoffs from a short call position, equivalent to that of a covered put
A covered option is a financial transaction in which the holder of securities sells (or "writes") an options contract, either a "call option" or a "put option", against stock that they own or are short, respectively.
The seller of a covered option receives compensation, or "premium", for this transaction, which can limit losses; however, the act of selling a covered option also limits profit potential and so the strategy reduces both risk and potential return. One covered option contract is sold for every hundred shares the seller wishes to cover.[1][2]
A covered option constructed with a call is called a "covered call", while one constructed with a put is a "covered put".[1][2] Both variants are a short implied volatility strategy.[3]
Covered calls
In a covered call, a trader buys or owns a stock and sells a call option on such stock. Covered calls are bullish by nature.[1][2] The payoff from selling a covered call is identical to selling a short naked put.[4]
Covered calls can be sold at various levels of moneyness. Out-of-the-money covered calls have a higher potential for profit, but also protect against less risk, as compared to in-the-money covered calls.[1]
Covered puts
Covered put options protect an option writer if the market price of the underlying asset drops far below the option strike price. In a covered put option, the option writer shorts the underlying asset and sells a put option to reacquire such asset.[5]
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Demby, Elayne Robertson. "Maintaining Speed -- In a Sideways or Falling Market, Writing Covered Call Options Is One Way To Give Your Clients Some Traction." Bloomberg Wealth Manager, February 2005.
Frankel, Doris. "Buy-writes Catch on in Sideways U.S. Stock Market." Reuters. (Jun 17, 2005).
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Schneeweis, Thomas, and Richard Spurgin. "The Benefits of Index Option-Based Strategies for Institutional Portfolios" The Journal of Alternative Investments, Spring 2001, pp.44 – 52.
Tan, Kopin. "Covered Calls Grow in Popularity as Stock Indexes Remain Sluggish." The Wall Street Journal, April 12, 2002.
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