What risks do you
face as the buyer of
Generally speaking, if the market value of the underlying asset falls, so does the value of
your call option. The value of your put option tends to fall if the underlying asset rises
in value. Normally, the less your option is in the money, the larger the fall in the option’s
value. In such cases, value reduction normally accelerates close to the expiration date.
What is a covered
With a covered option, you purchase an underlying asset (equity, bond or currency)
and simultaneously write a call option on that same asset. In return, you are paid a
premium, which limits your loss in the event of a fall in the market value of the
underlying asset. By the same token, however, your potential return from any
increase in the asset’s market value is limited to gains up to the option’s strike price.
Traditional covered options require that the underlying asset be lodged as collateral,
which makes you the covered writer.