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18.25. Risks of Writing Options

As the writer of a covered call option, the Investment Compartment forgoes, during the option’s life, the opportunity to profit from increases in the market value of the security covering the call option above the sum of the premium and the strike price of the call, but has retained the risk of loss should the price of the underlying security decline. In other words, as the Investment Compartment writes covered calls over more of its portfolio, the Investment Compartment’s ability to benefit from capital appreciation becomes more limited. The writer of an option has no control over the time when it may be required to fulfill its obligation as a writer of the option. Once an option writer has received an exercise notice, it cannot effect a closing purchase transaction in order to terminate its obligation under the option and must deliver the underlying security at the exercise price.

If the Investment Compartment writes call options on indices or baskets of securities that include securities that are not in the Investment Compartment’s portfolio or that are not in the same proportion as securities in the Investment Compartment’s portfolio will experience loss, which theoretically could be unlimited, if the value of the index or basket appreciates above the exercise price of the option written by the Investment Compartment.

When the Investment Compartment writes covered put options, it bears the risk of loss if the value of the underlying stock declines below the exercise price minus the put premium. If the option is exercised, the Investment Compartment could incur a loss if it is required to purchase the stock underlying the put option at a price greater than the market price of the stock at the time of exercise plus the put premium the Investment Compartment received when it wrote the option. While the Investment Compartment’s potential gain in writing a covered put option is limited to distributions earned on the liquid assets securing the put option plus the premium received from the purchaser of the put option, the Investment Compartment risks a loss equal to the entire exercise price of the option minus the put premium.