During volatile conditions, the level of premium that can be generated on call writing also typically increases. This additional premium could diminish the volatility of the investment compared to non-covered call strategies. The options premium helps serve as both a buffer and a measure of downside protection during market selling.
If the markets stay within range or are stuck trading in a more sideways action, investors would use the covered call strategy to generate a premium on the option or bank on the yields generated. If shares fall, the option expires worthless and one still keeps the premiums on the options.
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However, potential investors should keep in mind that the strategy can cap the upside of an ongoing rally. The trader keeps the premium generated but any gains beyond the strike price will not be realized. Consequently, in a stock market rally, the covered call strategy has underperformed the equities market.
Covered call strategies can create an alternative to current income investments and even complement a traditional portfolio of stocks and bonds. These types of options strategies are designed to offer investors with potential monthly income while seeking to lower the risk profiles of a variety of major index exposures.
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