Question

An investor has a portfolio of blue-chip stocks and anticipates stability in the market with the possibility of minor declines. This investor decides to write covered calls on the securities held in the portfolio. What is the result of this action?[A] The investor gains leverage on the underlying security by writing options contracts.[B] The investor is guaranteed not to lose premiums on the positions because the options are covered.[C] The investor can expect exercise notices on the calls if the price of securities held in the portfolio goes down.[D] The investor can expect income from the premiums received when selling the covered calls.

Answer 1

Answer:

D) The investor can expect income from the premiums received when selling the covered calls.

Explanation:

When an investor sells covered calls, but believes that the market will remain very stable, he/she is making money by selling the calls since they shouldn't be used. By selling the calls the investor is not gaining leverage and probably will end up not selling the stocks.

If the stock prices decrease, the options will expire and if the price increases, the investor would end up selling the stock and maybe even losing money. But the key factor is that the stock price should remain stable, therefore the investor earning from selling something he/she believes is useless to other investors.