Even those who do not know much of anything about investing or the stock market have heard of things like diversification. This is a method of spreading your risk around the market by purchasing a vast number of different kinds of stocks, and it is considered hedging your risk by doing this. However, there is one kind of hedging that seems to get less notice, and that is writing covered calls.
Covered calls are a bit of a complex form of option that is used by people who already hold a particular stock. It works as a hedge against potential losses within that stock. The following is an example of how one might work: You purchase a stock at $50 per share. You believe in the stock long term, but you don’t necessarily think that it is going to jump up in price in the very near future. If this is how you want to trade the stock, then you might sell covered call options to hedge some risk of holding that stock and making a little money while you what.
A covered call on this $50 stock might have a strike price of $55 per share. You could sell off these covered calls for any number of months in the future. Perhaps it would be just one month in the future or maybe six months. You will get different prices based on the amount of time and the strike price. When you sell off a covered call, you are selling the rights to buy one hundred shares per call at the strike price on the future date. This means that if the stock does not reach that price, then you make money on the trade. If it does go beyond that price, then you still make money, but you cap your gains.
Covered calls can be complex, so make sure to do your proper research in order to get it right when you do one for yourself.
