DEFINITION:
A covered call is a strategy where you sell the right for someone else to buy a stock you already own at a set price within a timeframe. In exchange, you earn extra income (a “premium”). It’s like renting out your stocks for cash while agreeing to sell them if the price hits a target.
WHEN AND WHY IT’S USED:
Covered calls are used to generate income from stocks a client plans to hold long-term. For example, if you own 100 shares of Apple and sell a covered call, you collect a premium today but must sell Apple at $200/share if it reaches that price by next month.
This strategy is popular in flat or slightly rising markets. If the stock doesn’t hit the target price, the client keeps the premium and the shares. It’s often used by retirees seeking steady cash flow or investors looking to reduce the effective cost of owning a stock.
IMPORTANCE IN ADVISOR – CLIENT COMMUNICATION:
Covered calls illustrate trade-offs between income and growth. Clients might focus on the extra cash but need to understand they could miss out on big gains. The advisor’s job is to weigh whether the income justifies limiting upside.
This strategy also introduces clients to options trading without excessive risk (since the client already owns the stock). Advisors can use it to demystify derivatives and show how they can be used conservatively.
Lastly, it emphasizes discipline. Covered calls require monitoring expiration dates and strike prices. Advisors must ensure clients are comfortable with the ongoing effort or delegate management to the advisor.
CONVERSATION EXAMPLE:
Client: “I own Microsoft shares but want extra income. What can I do without selling?”
Advisor: “Let’s sell covered calls. You’ll earn premiums monthly, but agree to sell Microsoft at $300 if it hits that price.” Advisor: “If we write covered calls on your energy stocks, we can generate 5% annual income, but you might have to sell if prices jump.”