NEW YORK ( TheStreet) -- Exchange-traded fund provider Horizons just launched the S&P Financial Sector Covered Call ETF ( HFIN), the firm's second U.S. fund. Horizons is a big player in the Canadian ETF market.
The covered call strategy is intended to generate income beyond just owning the stocks -- or in this case an index -- by selling call options. Specifically, a call option allows the buyer the right but not the obligation to buy stock at the option's strike price if he so chooses. The seller of the option is obligated to sell stock he owns at the option's strike price if the option buyer wants to buy. The option seller receives a premium which can be extra income from holding the stock.
As an example, an investor might buy 100 shares of Johnson Controls (JCI) for $50 per share. He might then sell a January call with a strike price of $55 for 30 cents per share. When the option expires in January, the stock will be either above or below $55. If it is above $55, then the option buyer will exercise his option to buy the stock at $55, obligating the option seller to sell his stock.
If the stock is below $55, then the option seller likely gets to keep his stock and would still have the 30 cents from selling the option. An investor who sells call options is looking for extra income and hopes that the stock doesn't go above the strike price before expiration. In the example above, if Johnson Controls went to $60, then the option seller would have forgone another $5 per share in price appreciation to make 30 cents in option premium.