Covered Calls, in Plain English

The borrower side is free because the collateral is productive. This section explains how.

A covered call is one of the oldest income strategies in finance. You own a share. You sell someone else the right to buy that share from you at a fixed price, called the strike, before a fixed date, called the expiry. For granting that right, they pay you a premium, upfront, in cash.

Three things can happen between when you write the call and when it expires.

• If the share trades sideways or down, the option expires worthless. You keep the premium and the share.
• If the share rallies but stays below the strike, the option still expires worthless. You keep the premium and the share, and you also got the upside up to the strike.
• If the share rallies past the strike, the option gets exercised. You sell the share at the strike. You keep the premium. The only thing you "give up" is the upside beyond the strike for that one cycle.

Done systematically over time, against a well-chosen and rebalanced portfolio, this strategy harvests what academics call the Volatility Risk Premium, which is the persistent historical tendency for implied volatility (the price of options, set by what buyers are willing to pay) to be higher than realised volatility (what actually ends up happening in the underlying stock). The gap, averaged across the market and across decades, is real, stable, and well documented.