Covered call writing at first often appears to be a bit convoluted. However, it is a conservative and safe process that helps protect the investor and maximizes income and/or profit. A covered call is a component in answering the question, “how to trade stock options.”

First, understand the nature of a call option. If you want the ability to buy a stock at an agreed-upon price by a given date, you seek a call option. Once you own some call options, you can sell them to others, typically for a premium (fee or income). Should you also own the shares of the stock identified by the call, you now have engaged in covered call writing.

But, how does covered call writing enhance model stock portfolios? For example, assume you have 100 shares of ABC, Inc. worth $10,000. You sell call options for this stock for $1,200. You pocket the income and wait for the buyer to exercise their options. Should the stock price decline, you are protected unless the loss exceeds the $1,200 you’ve already received. Such a decline will usually influence the call owner NOT to exercise the option, since they can buy the stock for less on the market. But, you’ve already made $1,200 or, worst case, lowered your potential loss by that amount. You win either way.

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