Question

You have 5,000 shares of Amazon (AMZ) currently valued at $1,928.42 but your omniscient Bubbie Tzeitl (grandma) just had a dream that an Amazon delivery drone will into a flock of Bald Eagles causing a huge national backlash against the company. If you believe in her “dark and horrible dream”.

a. Describe how you could protect against a short-term decline in the stock price using a:

i. Call option

ii. Put option

iii. futures contract

b. Which method would you recommend? Why?

Answer 1

Call Option gives Right to BUY the Stock at Strike Price. Put Option gives Right to SELL the Stock at Strike Price. Futures Contract is simply an agreement to Buy or Sell at a FUTURE DATE.

Call is completely useless, because we should be able to sell in case it falls a lot.

Futures have unlimited risk. Therefore, if stock rises, it will result in loss.

Put has a limited risk. Only by paying a small premium, we will have a RIGHT to Sell at the Strike Price.

Therefore, Put Option is the Best Option to cover risk at limited cost.