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Covered calls can be a way to generate extra
income from your stocks. They are essentially the opposite to call
options. If you do a covered call you are selling call options. The
options purchaser has the right to buy your stock at a predetermined
price, the strike price.
You get paid in advance, but your stock is tied
up for term of the contract, i.e. you cannot sell your stock. If the
stock doesn't rise past the strike price before it expires then you
get to keep your stock and the income generated from the covered
call. If the stock goes above the strike price of your contract, you
have to sell it because the guaranteed price is now lower than the
market.
The foundation of a covered call is that you must
own the stock. If you sell a covered call of a stock you do not own,
then you will literally have unlimited risk. This is know as a
naked call because you don't have the stock to cover your
contract.
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