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In: Finance

Explain the advantages and disadvantages to a covered call writer of closing out the position prior...

Explain the advantages and disadvantages to a covered call writer of closing out the position prior to expiration.

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Expert Solution

Covered call writing is when you own a stock and you are selling a call option on that stock. The idea behind doing this is when you are not expecting much upward movement then you want to earn premium by writing a call option on that stock. The major advantage of closing your position before the expiry is if your position is in loss then you can limit your losses on that option. The second advantage is when there is sudden upward move and you expect that the move will continue then by closing on the option you are opening the possibility of gain on the stock price movement. The disadvantage of closing the position prior to expiration is if there is not enough liquidity in that then you might end up paying more premium than you would have normally paid. If you are closing it prior to expiration then some part of your gain on stock would go towards the losses on the call if your position has moved unfavorably.


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