Insurance entities usually write covered-call options because they consider the premium received for writing the options to be either:
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A. B. C. D.D
Covered call options are a common strategy used by insurance entities to generate income from their investment portfolios. In this strategy, the insurance company owns a particular security, such as a stock or bond, and simultaneously sells (or writes) call options on that security.
The call option gives the buyer the right, but not the obligation, to purchase the underlying security at a specific price (strike price) within a certain time frame. In exchange for this right, the buyer pays a premium to the seller of the option (the insurance entity).
So, the premium received by the insurance entity for writing the covered call option can serve two purposes:
A) Economic hedge: By selling the call option, the insurance company is essentially taking on an obligation to sell the underlying security at the strike price if the option is exercised by the buyer. This creates a limited downside protection for the insurance company, as the premium received reduces the cost basis of the underlying security and provides some protection against a decline in the market price of the security. This allows the insurance entity to generate some income while still maintaining exposure to the security.
B) Decrease in yield: The premium received from the sale of the call option increases the overall yield on the underlying security. This is because the premium provides additional income to the insurance entity, which can increase the yield on the investment. This additional income can be attractive to insurance companies that are looking to generate additional income from their investment portfolios.
Therefore, the correct answer to the question is (C) Both A & B. Writing covered call options can provide an economic hedge against a decline in the market price of the underlying security and also increase the overall yield on the investment.