You seem to just not grasp the magnitude of what you assume people should do in this crazy option proposal. It is not unusual for a stock to have a 25% short interest. That means a quarter of the shares are sold short. So you are saying a quarter of shareholders should sell calls to every short seller who wants to hedge? What if most shareholders do not want to sell options, and not give up the upside in doing so (indeed, there is a tradeoff in "juicing" your return, you lose the upside). In fact, most do not, so this is entirely impractical of course.
The whole point is with proper regulation that prevents the case of a squeeze or errant prices that are not sound, you prevent the "unlimited" downside (if a company ever becomes infinitely valuable, we will have other more interesting issues to deal with). This happens all the time--exchanges can cancel trades done at what are called "obvious error" prices. Regulation effectively clips the tail, which is why dealers have no problem shorting shares to ensure liquid markets.
But I think my original point remains valid. As long as short sellers buy sufficient options to hedge their positions, and those options are only sold by investors who actually own the stock, then no one is exposed to unlimited downside. And I fail to see how any trade that carries unlimited downside could ever be considered a "smart speculative bet" from any standpoint, regardless of whether it's economically right or wrong.