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  #1  
Old 27th November 2010, 08:05 PM
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Default Protecting a Short Position with Options



I sell 100 shares of ABC Co. short at $80. Also, I buy a 70 call option for $5 to protect against the stock price going up.
1. If the stock ends up at $100, what will be my overall gain/loss?
2. If the stock ends up at $50, what will be my overall gain/loss?
3. What is the most I can lose under this short sale-call option plan?
4. If I have an unprotected short sell position (no call option), what is the most I can lose?
5. Under the condition described in part (4), if I had a limit order to buy the stock and close down the position at $60, what is the most I could lose?

Thanks all for leaving me a solution.
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  #2  
Old 27th November 2010, 08:16 PM
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Originally Posted by Paul Yeoh View Post
I sell 100 shares of ABC Co. short at $80. Also, I buy a 70 call option for $5 to protect against the stock price going up.
1. If the stock ends up at $100, what will be my overall gain/loss?
2. If the stock ends up at $50, what will be my overall gain/loss?
3. What is the most I can lose under this short sale-call option plan?
4. If I have an unprotected short sell position (no call option), what is the most I can lose?
5. Under the condition described in part (4), if I had a limit order to buy the stock and close down the position at $60, what is the most I could lose?

Thanks all for leaving me a solution.
Is this your homework ?
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Old 27th November 2010, 09:24 PM
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Originally Posted by Atiker View Post
Is this your homework ?
Yes. It's one of my CFA I questions. I'm quite confused about part (3) since the question did not mention when did I initiate both the position. I suppose there would be no loss will occur to my position.

Anyone there can help? Thanks a lot.
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  #4  
Old 28th November 2010, 08:48 AM
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Originally Posted by Paul Yeoh View Post
I sell 100 shares of ABC Co. short at $80. Also, I buy a 70 call option for $5 to protect against the stock price going up.
70 is the strike price or 70 is the number of options?
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Old 28th November 2010, 09:37 AM
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Let me put in a counter question,

When you sell short at 80 who would sell you a 70 strike price call option for $5 when the intrinsic value of the option itself is $10 without even adding time value & volatility?
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Old 28th November 2010, 10:00 AM
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When you sell short at 80 who would sell you a 70 strike price call option for $5 when the intrinsic value of the option itself is $10 without even adding time value & volatility?
It is not mentioned anywhere that the option position and short position were opened at the same time.

Also, to calculate the exact profit/loss from an option position, both the strike price and the number of options purchased/sold has to be known.

The data provided is insufficient unless we assume one of the two variables - either the strike price or the number of options purchased by the short seller.
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Old 28th November 2010, 10:19 AM
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Originally Posted by Alchemist View Post
70 is the strike price or 70 is the number of options?
70 is the strike price. It's not a number of options purchased.
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Old 28th November 2010, 11:02 AM
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Originally Posted by Alchemist View Post
It is not mentioned anywhere that the option position and short position were opened at the same time.

Also, to calculate the exact profit/loss from an option position, both the strike price and the number of options purchased/sold has to be known.

The data provided is insufficient unless we assume one of the two variables - either the strike price or the number of options purchased by the short seller.
I assumed both trades were executed at the same time.

It's not an individual position but like parts of the same picture,the strategy combines both the short position and long option to create a modified risk profile that is different from either of the strategies put in place individually.

Quantity is equal since 100 shares are sold and 1 call option contract (100 shares) is purchased.

Last edited by kris_mar : 28th November 2010 at 11:32 AM. Reason: small corrections
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Old 28th November 2010, 11:46 AM
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Quote:
Originally Posted by Paul Yeoh View Post
I sell 100 shares of ABC Co. short at $80. Also, I buy a 70 call option for $5 to protect against the stock price going up.
1. If the stock ends up at $100, what will be my overall gain/loss?
2. If the stock ends up at $50, what will be my overall gain/loss?
3. What is the most I can lose under this short sale-call option plan?
4. If I have an unprotected short sell position (no call option), what is the most I can lose?
5. Under the condition described in part (4), if I had a limit order to buy the stock and close down the position at $60, what is the most I could lose?

Thanks all for leaving me a solution.
Cost =$5 (per share).

1.Overall gain is (-5 + 30 - 20)=5/share. Thus for 100 shares $5 * 100 =$500.

2.Overall gain is (-5 + 0 +30)=25/share. Thus for 100 shares $25 * 100=$2500.

3.Under the current circumstances you can't lose since you get a $5 gift(in terms of your cost) so your minimal gain is $5 per share or total of $500.

4.Infinity.

5.Since you sold short at $80 IF you can buy back the stock at $60 you would make a $20 gain per share or $2000.
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