Define: Covered Option

A covered option refers to an options contract where the seller (writer) of the option owns the underlying asset that the option is based on. This ownership provides a “cover” for the seller in case the option is exercised.

Yes, covered options are legal financial instruments that are traded on regulated exchanges. They are subject to the rules and regulations set forth by the relevant financial authorities.

In a covered option, the seller of the option owns the underlying asset, such as stocks or commodities. If the buyer of the option exercises it, the seller can fulfill their obligation by delivering the underlying asset at the agreed-upon price.

Trading covered options can provide income through the premiums received from selling the options. It also allows investors to potentially profit from the price movement of the underlying asset without actually selling it.

The main risk of covered options is that the price of the underlying asset may decline significantly, resulting in potential losses for the seller. Additionally, if the option is exercised, the seller may have to sell the underlying asset at a lower price than the current market value.

Generally, anyone who meets the requirements set by the exchange and brokerage firms can trade covered options. However, it is important to have a good understanding of options trading and the associated risks before engaging in such transactions.

The taxation of covered options can vary depending on the jurisdiction and the individual’s tax situation. It is advisable to consult with a tax professional to understand the specific tax implications of trading covered options.

Yes, covered options can be used as a hedging strategy to protect against potential losses in the underlying asset. By selling covered call options, investors can generate income while providing a level of protection against downward price movements.

Some common strategies involving covered options include covered call writing, where investors sell call options on their owned stocks, and covered put writing, where investors sell put options on stocks they are willing to purchase. These strategies can be used to generate income or acquire stocks at a desired price.