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A covered option is a financial transaction in which the holder of securities sells (or "writes") a type of financial options contract known as a "call" or a "put" against stock that they own or are shorting. 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 their profit potential to the upside. One covered option 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] This strategy is generally considered conservative because the seller of a covered option reduces both their risk and their return.[1]
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Covered calls are bullish by nature, while covered puts are bearish.[1][2] The payoff from selling a covered call is identical to selling a short naked put.[3] Both variants are a short implied volatility strategy.[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]
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