Stock and Option Hedging - Long Stock Writing Options - Series 7 Tutorial

Buying Stock and Writing (selling) call options as a hedge is a long practiced options strategy for decades. It is also a position that is tested on the Series 7 exam and what Brokers-Traders need to know.

A stock hedge with writing call options is an income strategy - also called covered call writing.

Selling or shorting call options on their own is a dangerous undertaking in the stock trading markets. Shorting option contracts that are NOT covered requires that person to deliver (sell) shares of stock to the call holder at a specific price. If the writer does not own the stock, there is an unlimited loss potential - since the stock can rise to an infinite amount.

Owning the stock "covers" the option. If the option is exercised, the stock is used to fulfill the obligation on the contract.

Strategy Example

Long 100 Shares @$80
Short 1 Feb 85 Call for $300

The Maximum gain, loss and break-even are all tied to the stock performance and the premium received on the option.

The break even is 77. The stock is owned at 80, but the investor received a $300 premium which lowers the overall cost to $7700

The Maximum loss is that total outlay of money. $7700. The $8000 of stock could decline to zero, but the $300 would be retained.

The Maximum gain is the difference between the purchase price and the strike (sell) price on the contract.  That difference is $300 + $300 for the premium received for a total maximum gain of $600.

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