Question

An investor sells 100 shares of ABC short at $43 (per share) and buys 1 ABC October 45 Call for $3. What is the investor’s maximum loss?

Answer 1

As investor shorted, so fear of stock price going up. Call gives the right to buy stocks at a specified price. So call at 45 and shorting at 43. If the stock price goes above 45, the call will protect the investor. The risk is in between. There is a gap of (Short price - Strike price of call) => 43 - 45 = 2

So the investor is not protected for this $2 and he spent $3 to buy each call. So total loss per share is ($3 + $2 = $5)

Maximum Total Loss = Number of shares * Max loss per share

= 100 * 5

= 500