Call Options

• The purchaser of a call option has the right, but not the obligation, to buy a stock at a specified price, called the strike price, on or before a certain date. The purchaser pays a fee, known as the option premium, for this privilege. A seller, called the writer, of a call option has the obligation to sell the stock at the specified strike price if the call option purchaser decides to exercise his right to buy the stock. Each option contract represents 100 shares of the underlying stock.
  
  

Covered Call Writing

• An investor sells call options to generate additional income for stocks that he already holds in his portfolio. This strategy is known as covered call writing. This type of investor has a bullish view of his stock for the long term, but he does not believe that the stock price will rise above the strike price of the call option in the short term. This strategy works particularly well in flat markets. A call option writer keeps the premium no matter what happens with the price of the stock. If the market price remains below the strike price, the call option expires unexercised, and the writer retains ownership of his stock. He can continue writing call options on his stock to generate more income as long as there is not a substantial rise in the market price.
  
  

Naked Calls

• Selling a call option without owning the underlying stock is known as a naked call. The writer of this call option expects the market price of the stock to remain stagnant or above the strike price so that the option expires unexercised, and he gets to keep the premium. However, naked call writing has substantial risks. If the market price of the stock rises significantly, the naked call writer has to purchase the shares in the open market at the higher price and then sell the stock to the call option holder at the lower strike price. Under this situation, the potential for loss can be substantial.
  
  

Strategies

• The investor's risk tolerance level and expectation of future market trends determines which strategy to use when selling call options for income. A conservative investor will follow the covered call writing strategy to generate income. Since he continues to own the stock, he also receives dividends and retains his voting rights. However, covered call writing will not protect the investor from the losses of a significant decline in the price of his stock. The naked call writer is more of a speculator. This strategy works best in bearish or stagnant markets.