What is a Covered Writer? A Comprehensive Legal Overview
Definition & Meaning
A covered writer is an individual or entity that sells or writes a call option while owning the underlying asset or having sufficient cash to purchase it if necessary. This strategy minimizes risk because the covered writer can deliver the asset they already own rather than needing to buy it at potentially higher market prices. In essence, they are prepared to fulfill their obligations without incurring significant losses.
Legal Use & context
The term "covered writer" is primarily used in the context of financial and investment law. It relates to options trading, a practice governed by various regulations and legal standards. Covered writing is often employed in investment strategies to generate income while managing risk. Users can engage in this practice using legal forms and templates provided by services like US Legal Forms, which can help them navigate the complexities of options trading.
Real-world examples
Here are a couple of examples of abatement:
Example 1: An investor owns 100 shares of Company XYZ, which is currently trading at $50 per share. They sell a call option with a strike price of $55. If the option is exercised, they can deliver their shares without needing to buy them at the market price.
Example 2: An investor has $5,000 in cash and sells a call option on a stock they are interested in. If the option is exercised, they can use their cash to purchase the shares at the strike price (hypothetical example).