Covered Call & Analysis
A covered call is an investment strategy used that requires investors to sell the rights to someone to purchase stock at a predetermined price when the option rights expire. Purchasing and selling covered calls requires analyzing the stocks prior to the covered call option.
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Explanation
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A covered call occurs when a person who owns stocks sells an option to another investor. This option allows the investor to purchase these shares of stock at a set price before the option expires. The investor purchasing the option is not required to purchase the shares, but has the option to do so. The investor must analyze whether or not exercising the covered call option will benefit him or not.
Profiting
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The owner of the shares of stock profits through a covered call when the buyer of the option purchases the option. The buyer pays the seller a cash premium which the seller keeps regardless whether the buyer purchases the stock or not. The seller benefits if the investor opts out of the transaction as long as he can sell the stock and make a profit.
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Example
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A covered call is purchased by a stock owner when the stock owner believes the price of the stock will increase. If stock option is purchased for $20 a share and the investor feels the stock will go up to $40 a share in one year, the investor might choose to place the stock into a covered call. The investor is willing to sell for $30, making a good profit, but possibly missing out on more. Therefore, the investor chooses to use a covered call for $30. The investor is then guaranteed a premium from a buyer purchasing this option, and if the buyer purchases the option when it expires, they make a profit.
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