Covered call writing refers to a strategy where investors write call option contracts while owning the same amount of underlying stock shares. In situations where the stock is bought at the same time that the call contract is written, this is called a buy-write. When the shares are from a purchase that was previously made, the strategy is called an overwrite. In all these cases, the stock has to be held with the brokerage account that the investor used to write the calls. It is one of the basic strategies that are used by and involve combining stock ownership with the flexibility of the options.
This strategy can be applied in diverse market conditions but investors usually use it when they think the underlying stock's market value will not have a lot of range over the call contract lifetime. In this case, the investor wants to generate more income from the underlying stock shares. It also gives limited protection in case the stock value decreases.
One of the main advantages of this strategy is that it provides limited protection in case the underlying stock price declines. It also allows an investor to keep the premium that is received when the call is written. The investor can also appreciate all the advantages that come with owning the underlying stock including voting rights and dividends. This strategy is considered to be a conservative one because the stock ownership risks decrease.
To get maximum profits when using this strategy, the price of the underlying stock has to be more than the price of the call option. An investor still faces some risk of financial loss when using this strategy and it comes from the stocks that are held. The loss can be huge if the stock price keeps declining as the call contract expires.