My question is Please discuss about the following statement
“ the advantages and disadvantages of writing a call option on an existing portfolio of stocks”
I read an article nearly about that, and I think such a question, but I could not generate a sound idea about that.
Thanks a lot!
—- My answer
The long stock profit equation is $\pi = N_s (S_F - S_ 0)$
The short call profit equation is $ \pi = - N_c [max(0, S_F -X) - C]$
Consider the bullish market expectation, that’s, the stock price is increasing.
If we have only long stock, then the maximum profit from this long stock is infinite. It generates positive infinite profit.
But if we have only short calls, then since the higher stock price is increasing, the final stock price will exceeds the exercise price, so the call fill finish in the money. And thus, the counter party will exercise it, but we generate a loss. And the maximum loss is negative infinity in theory.
As a result, for the bullish market expectation, short call has a disadvantage, but long stock has a advantage.
Next, consider the bearish market expectation, that’s, the stock price is decreasing.
If we have only long stock, then it generates an infinite negative cash flow. We have a big loss.
If we have only short call, then since the stock price is decreasing, the call will finish out of the money, so the counter party won’t exercise it, so we generate a positive profit. We have a constant positive profit.
As a result, for the bearish market expectation, short call has an advantage, but long stock has a disadvantage.
If I put the profit diagrams of short call and long stock together, which one is true? (I cannot decide it at this point)