Understanding a Covered Call

One of the huge advantages to trading options is the ability to trade in any type of market environment. Whether the market is moving higher, lower or sideways, there are option strategies that can make profits.

However, sometimes the sheer number of strategy choices can be a detriment. Nonetheless, it doesn't mean we should just stick to one strategy, as this will take us out of the market during some of the best times to be in. One strategy that tends to get more attention than any other -- though it is often used incorrectly, adding to the risk of the trade -- is a covered call.

Before we talk about the pros and cons of a covered call, let's first define what it is. A covered call is the selling of a call against an underlying security. For example, we might buy Microsoft (MSFT Quote) stock at $20, and then sell a 20 call against the stock. This strategy has been popular among so-called options gurus because of its simplicity. It's also considered to be safe, making it a strategy of choice for IRAs.

But there are better strategies to use than a covered call. Nonetheless, there's a place for this strategy, which we'll also discuss. ...