Chapter3 - Chapter Three Basic Option Strategies Covered...

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Chapter Three Basic Option Strategies: Covered Calls and Protective Puts Answers to Problems and Questions 1. Covering a call means either 1) buying back a call that you previously wrote, or 2) adding a stock or long option position so that a short call is no longer uncovered. A covered call is a short call in combination with a long position in the underlying stock. 2. The maximum loss is known and limited with a long put, while the maximum loss is unlimited with a short sale. The maximum possible profit is similar for the two strategies. 3. A perpetual European option could never be exercised, and consequently has no value. A perpetual American option would have value. 4. If prices decline sharply, put overwriting causes the portfolio to lose twice, once from the decline in the underlying asset and again from the puts going in-the-money. 5. Protective puts serve the same function as insurance. They reduce risk, and there is often a benefit to doing so.
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