A covered call is an options trading strategy where an investor who owns a financial instrument (typically a stock) sells call options on that asset. The strategy is considered “covered” because the investor owns the underlying asset that the call options are based on. This strategy is also known as a “buy-write” strategy.

Here’s how the covered call strategy works:

1. **Own the Underlying Asset:** The investor owns shares of a stock.

2. **Sell Call Options:** The investor sells (writes) call options on the same stock. Each call option represents the right, but not the obligation, for the buyer to purchase a specified number of shares at a predetermined price (strike price) within a specified time period (until expiration).

3. **Receive Premium:** In exchange for selling the call options, the investor receives a premium (payment) from the buyer of the options.

4. **Obligation to Sell:** By selling the call options, the investor takes on the obligation to sell the underlying asset at the agreed-upon strike price if the buyer of the call options decides to exercise them.

This strategy can be profitable in different market scenarios:

– **If the Stock Price Rises Moderately:** If the stock price remains below the strike price of the call options, the options may expire worthless, and the investor keeps the premium received. The investor still owns the underlying stock.

– **If the Stock Price Remains Unchanged:** If the stock price stays relatively stable, the investor keeps the premium received from selling the call options.

– **If the Stock Price Falls:** While the premium received provides some downside protection, the investor may still experience losses if the stock price declines significantly.

– **If the Stock Price Rises Above the Strike Price:** The investor’s gains from the stock’s rise are limited to the strike price plus the premium received. If the stock price rises significantly above the strike price, the investor might miss out on some potential profits.

Investors often use covered calls to generate income from their stock holdings and provide some downside protection. It’s a strategy that requires a careful assessment of the investor’s outlook for the underlying stock and risk tolerance. Additionally, investors should be aware of the potential opportunity cost if the stock experiences significant price appreciation.