ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Covered Options

Updated on November 4, 2009

Covered Options

When people mention the term “covered options”, it may be a little confusing to a newcomer (as almost all options terminology is). Sometimes I wonder why in the world the investment community wanted to make the jargon and vocabulary of trading so doggone convoluted, but then again, in the world of investments and finance, hardly anything makes sense anyway. If you doubt this, especially in the world of options trading, just take a look at the Black & Scholes options pricing model—it’s a mind-bender for the average person, and honestly, I’m not fully sure that I understand it myself. But the cool thing is that you really don’t have to grasp every single complicated mathematical formula to profit from trading covered options, or any other option for that matter; you just have to keep it simple and remember that if you buy call options, life is good if prices are going up, and if you buy put options, life is good if prices are going down. I still don’t quite understand the public’s perception of a falling market being bad. But if you look on any average newscast, if the Dow or the NASDAQ has a down day, they make it seem like the apocalypse is coming. Let me tell you, if you were holding a large amount of Dow put options and the Dow sank 800 points, you’re a very happy man. Again, it’s all about perspective. Unfortunately, in the world of stock trading, one man’s loss is another man’s gain; it truly is a zero-sum game we play. But, just because the markets have risk, it doesn’t mean that your behavior needs to be risky to trade them. This is where covered options really come into play. What do I mean specifically by covered options? Well, let me give you a common example. Let’s say that stock XYZ is trading at $30.00 per share, and you own 100 shares of it. So, your current portfolio value (if you only had those 100 shares of XYZ stock) would be at $3,000. If the stock were to start tanking, and ended up at around $18.00 per share, you would have truly lost some money, my friend (albeit it’s an “unrealized loss” as long as you haven’t closed out the position). Now your portfolio value is only around $1,800, which is almost a 50% loss—that sucks.

Image courtesy of Google Images (
Image courtesy of Google Images (

Covered Calls and Covered Puts

Enter the world of covered options. You can actually hedge that loss by selling call options against your position. What do I mean? Since you own 100 shares of XYZ stock, you have the right to sell (or write) one call option to another investor, and that investor will pay you a premium for the right (but not the obligation) to exercise (or “cash in”) a call option contract, giving him the right to buy 100 shares of your stock at a designated strike price. Let’s say that back when the stock was trading at $30.00, you sold a call option with a $30.00 strike price. For ease of math (and I know I’ll probably get blasted by some options “experts” on this for not doing any actual calculations), let’s say that the call option cost 5.00, or $500.00. This would be the amount of premium you would receive (less commissions and fees) into your account once you wrote (a.k.a., sold) the option. The investor would now hold a long call option with your 100 shares of stock as the underlying instrument, and you would be “short” one call option with a $30.00 strike price. Let’s say that, as in our earlier example, your stock takes a swan dive and ends up at $18.00 per share. Normally, it would be a $12.00 per share loss to your account, resulting in a total open loss of $1,200, but since you sold the $30.00 strike call option and received the $500.00 cash premium from that sale, your net loss (not considering commissions and fees) would be only $700.00, because the cash received from the call option you sold will hedge your account against the total loss of $1,200. I don’t know about you, but losing $700.00 would be a lot less painful than losing $1,200. So, you see how having covered options can really benefit you in the area of hedging your overall risk. The above example I just explained is actually what’s known as “writing a covered call”. It’s covered because there are 100 shares of actual stock to back up the call you wrote. In other words, if the investor wanted to exercise or “cash in” the option, you would then be obligated to sell him the stock for $30.00 per share, since $30.00 was the strike price of the call option. Now if you consider a scenario where the price of the stock were to rise to say $40.00 per share, the investor is sitting pretty, because you are still obligated to sell him the stock for $30.00 per share, although the going market rate is $10.00 above that. The investor would then be able to make a quick $1,000 profit from that type of move, because your option contract locked you into selling the stock to him for only $30.00 per share. So then, you see that the best scenario for writing covered options of any kind (puts would work the same way; just reverse all the prices and so forth) would be for the market to basically remain stagnant. This way, the premium received for the option you wrote wouldn’t have to be used for hedging against losses, because the stock’s price would remain relatively stable. This is the way that great returns are made on writing covered options. Hope you enjoyed this extremely long explanation…I’ll come back with more later.


    0 of 8192 characters used
    Post Comment

    No comments yet.


    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at:

    Show Details
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the or domains, for performance and efficiency reasons. (Privacy Policy)
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)