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One of My MBA Students Explains Covered Calls to a Teenager


One of the favorite topics in my energy trading classes is the Covered Call Options strategy.  Well, maybe it's just one of my favorites and my poor students don't have much say in the matter.  They have to like it if they want to pass my class. LOL!  

Anyway, I asked them to explain the risks and benefits of a covered call option strategy to a teenager.  Here's how MBA student Arjun Sreekumar breaks it down. 

Arjun: Hey kid. A covered call strategy is a great way to make money. Basically, you’re buying a stock – also known as going long a stock – and simultaneously writing a call – also known as selling a call option, or shorting a call. Now a call option is the right but not the obligation to buy a stock in the future.

Teenager: What are the benefits and risks of a covered call strategy?

Arjun: The main benefit of writing covered calls is that it is an income-generating strategy. Think of it like this: the exchange is paying you money to hold onto a stock that you already own. A covered call strategy will work well if the price of the underlying asset rises slightly or stays the same. While you can have heavy losses from writing covered calls if the price of the underlying falls significantly, the maximum gain can also be very high. The maximum gain will basically be the premium collected plus the difference between the strike price and the stock price.

Teenager: Can I write covered calls in my Roth IRA?

Arjun: Yes, you can. And the huge advantage of writing covered calls in a retirement account as opposed to a traditional account is that when you retire at the age of 60 or whatever, you can take out your profits from covered call writing tax free. That means Uncle Sam won’t touch a penny!

Teenager: Gee thanks, Arjun! I’m gonna go watch MTV and sit in my room and complain about life now.

Arjun: Stay in school, kid!