What You Should Know About Covered Call Options
Vision Advisors believes that it makes sound economic sense, to employ from time to time, a strategy of writing (selling) covered call positions against some or all of the stocks in portfolios. It is important to understand that the process of writing covered call options on stock requires owning the underlying stock itself. By means of this option writing program, Vision Advisors will attempt to enhance total returns in the portfolio by writing covered call options on its stock and collecting the premium (the cost to the option buyer).
Writers of uncovered (or “naked”) calls, unlike writers of covered calls, do not own the underlying stock. In this aggressive investment approach, the potential for profit is limited and the risk of loss is unlimited. Ownership of uncovered calls, in adverse markets, could result in the investor incurring substantial losses. Because of the substantial risk involved in writing uncovered calls, Vision Advisors does not recommend this strategy for its clients.
A Worst Case Scenario
The risk incurred by the writer of a covered call is limited because the writer owns the underlying stock. When the stock is “called” (or sold) at the strike price, the option writer sacrifices any additional gains above the level at which the stock was called, but still earns money from both the premium collected from writing the call and the appreciation in the underlying stock price up to the strike price. The worst case scenario of this strategy is that the option writer earns less money when his or her stock is “called” away. One should remember that, although the option writer collects additional income from the premium, the underlying stock is still at the risk of the market. However, rather than allow the underlying stock to be called away, it is possible to purchase stock on the open market for delivery to satisfy the exercised call option.
In a strong bull market, covered call option writing can limit gains as stock prices move above strike levels and stocks are called away. Conversely, in a bearish, sideways or mildly bullish market, writing covered calls can prove to be a highly effective investment strategy by potentially adding extra income with a measure of limited downside protection.
Risk Factors and Notes
- The use of Vision Advisors’ covered call writing strategies may add certain risks, which are fully described in Vision Advisors’ Form ADV Part II.
- Prospective investors should carefully review the Wrap Fee Program Brochure, for a complete discussion of the investment program, advisory fees and the risks of investing.
- Covered call writing involves transactional costs which reduce the benefits of covered call writing.
- Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (with 1997 through 2012 supplements), November 2012 supplement and April 2015 supplement to Characteristics and Risks of Standardized Options. Besides being accessible via our Web site, copies of the Options Disclosure Document are available from your Vision sales representative, or by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606.