Selling or shorting call options that are uncovered is a dangerous strategy in the stock trading markets. Shorting option contracts that are NOT covered requires that a person to deliver (sell) shares of stock to the call holder at a set price. If the writer (seller) does not own the stock, there is an unlimited loss potential - since the stock can rise to an infinite amount.
Owning or long the stock "covers" the option. If the option is exercised, the stock is used to fulfill the obligation on the contract.
Covered Call Strategy Example
Long 100 Shares @$60
Short 1 Feb 65 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 57. The stock is owned at 60, but the investor received a $300 premium which lowers the overall cost to $5700
The Maximum loss is that total outlay of money. $5700. The $6000 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 $500 + $300 for the premium received for a total maximum gain of $800.
