A covered call is an investment market transaction where the seller of covered calls has the right to buy the corresponding quantity of an underlying asset, such as stocks of a particular stock or any other financial securities. In essence, a covered call transaction is just like a naked call on an underlying asset. It is not an option to trade on the stock exchange because the seller does not need to hold the underlying asset.
There are several types of covered calls that a trader can use and most of them are basically the same for stocks, mutual funds, and bonds. One type of covered call that you might want to know more about is a naked call.
Naked calls are covered calls, but they are not called naked calls for two reasons. First, if the underlying asset has a value that is less than what is owed to the trader, it can be considered as a put option instead. Second, in some cases, the naked option itself can be written off, depending on the position.
Naked calls are a good option for people who do not own shares of an underlying asset. Since the option seller has the option to buy the underlying asset at the strike price, he/she is basically betting that the price will rise, therefore making a profit. Usually, these calls come with higher strike prices, which are typically much higher than the prices of underlying securities. They are usually purchased before the market closes in order to avoid incurring losses.
Naked calls carry a very low risk. Unlike other options that have high risk, a naked call gives traders a lot of comfort, as it is very unlikely for it to go against the market. Also, since the seller has the option to buy the underlying asset at the strike price, he/she is not required to pay any commission for the transaction.
However, some traders also use naked calls when they have no shares of underlying assets to sell and therefore do not require holding the underlying asset. This can result to an increase in margin requirements. For these kinds of situations, it is recommended that traders use a covered call that is not a naked option in order to minimize the amount they need to borrow from their broker.
When it comes to buying covered calls, mutual funds are considered to be your best bet. Since mutual funds provide you with liquidity and a variety of investments that you can choose from, there is always a mutual fund that can suit your needs. The most common option is to buy a short-term or long-term mutual fund, as both provide diversification in your portfolio. The major benefit of buying mutual funds is that the transactions cost you little.
Another option is to go for a long-term investment vehicle such as an index fund that can grow with time. Most investors prefer these funds because they offer more stability, since there is no risk of loss with each purchase. A covered call can also be used to invest in a variety of products such as indexes, currencies, commodities, and even bonds and mutual funds, thereby increasing your risk exposure.
While there is not much risk involved in purchasing covered calls, investors need to know how to protect themselves from losses. This is why the call option contracts can become more expensive over time. The most important way is to limit your purchase of the underlying asset to a small percentage of its market value, or in other words, do not exceed the initial covered call strike price.
In addition to buying a covered call, you can also enter into a futures trading deal or a put option contract. There are risks involved in either type of option contract, so it is recommended that you seek advice from a broker who specializes in options and futures trading before you start trading. These kinds of contracts involve risks in both directions and therefore should be studied carefully before you decide whether or not to go ahead.
Option trading is a lucrative venture for those who want to earn a little money with their spare time. It is a good investment strategy that can help you achieve your financial goals. Although there are some risks involved, if you know how to minimize your losses and choose the right options, it can prove to be a profitable venture for you.