Covered Call Definition

A covered call is an investment strategy involving two transactions.

1. You buy stock (or use stock you already own).

2. You sell a call option against that stock.

The combination of being long the stock and short a call option is called "covered call." It is also known as a "buy-write" transaction (because you buy the stock and write (sell) the option).

Because 1 option controls 100 shares (we'll get to that in the next section), the covered call definition can be expressed this way, too:

1 covered call = long 100 shares stock + short 1 call option

It's called "covered" because, as the seller of the option, if the call option is exercised you already own the stock you need to fulfill your obligation to deliver the 100 shares. There are no unbounded liabilities in a covered call situation.

Naked Call Definition

It is worth mentioning that there is another kind of call option definition: "naked" (also known as "uncovered").

The definition of a naked option is one where you have sold (shorted) the option but do not own an offsetting position of the underlying stock.

Selling naked options is extremely risky and represents potentially unlimited liability to the seller. It requires constant monitoring by the seller but even then a sudden move can cause dramatic losses. It is the OPPOSITE of what covered call writers do. We do not encourage or recommend running with scissors or naked option writing; you could get seriously hurt!

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