Question

_Leo owns some AAPL but is unhappy with the dividend, would like to generate some additional income from this holding, and has the notion that the stock is going to hover around its current price for awhile. In order to generate this additional income, Dave could

a. sell naked calls.

b. sell covered calls.

c. buy naked calls.

d. buy covered calls.

e. buy call options on Samsung.

Answer 1

covered call is an options strategy involving trades in both the underlying stock and an options contract. The trader buys or owns the underlying stock or asset. They will then sell call options (the right to purchase the underlying asset, or shares of it) and then wait for the options contract to be exercised or to expire.

Exercising the Option Contract

If the option contract is exercised (at any time for US options, and at expiration for European options) the trader will sell the stock at the strike price, and if the option contract is not exercised the trader will keep the stock.

A put option is the option to sell the underlying asset, whereas a call option is the option to purchase the option. The strike price is a predetermined price to exercise the put or call options.

For a covered call, the call that is sold is typically out of the money (OTM), when an option's strike price is higher than the market price of the underlying asset. This allows for profit to be made on both the option contract sale and the stock if the stock price stays below the strike price of the option.

If you believe the stock price is going to drop, but you still want to maintain your stock position, you can sell an in the money (ITM) call option, where the strike price of the underlying asset is lower than the market value.

When selling an ITM call option, you will receive a higher premium from the buyer of your call option, but the stock must fall below the ITM option strike price—otherwise, the buyer of your option will be entitled to receive your shares if the share price is above the option's strike price at expiration (you then lose your share position). Covered call writing is typically used by investors and longer-term traders.

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