Long Stock vs. Short Option

Before we discuss covered calls, let's review the terms "long" and "short".

In investment lingo, you are long a security if you own the security. You bought it, you own it, and you will profit if it goes up in value. This is the normal case for most investors. You buy 100 shares of XYZ stock, and now you are long XYZ.

On the other hand, you are short a security if you have sold it without owning it. Short sellers will buy the security back at a later date (i.e. they cover their short position in the future by buying what they had previously sold).

The reason you would short something (sell something you don't own) is because you expect it to fall in value. You hope to buy it back at a later date for less than you sold it for today.

For example, if you think ABC stock will decrease then you can sell 100 shares (which you don't currently have). You receive cash from the sale today and are now short 100 shares of ABC. Your brokerage statement will show -100 (negative 100) as the number of ABC shares you own. At some point you will need to buy 100 shares of ABC to cover your short position.

Covered call investors do not short stock, but do short call options. It is the short option that generates the income for a covered call investor. See next page...

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