Question

Suppose that you just sold 100 call options on Apple’s stock with a strike price of $120. The current market price of Apple’s stock is $110. If you are worried about potential big losses from the options you sold, what is the best way to hedge against the risk?

a) Buying 100 shares of Apple’s stock

b) Selling 100 shares of Apple’s stock

c) Buying 100 put options with a strike price of $120

d) Selling 100 put options with a strike price of $120

Answer 1

Option (a) : Buying 100 shares of Apple's stock.

Explanation:

Here, we have sold 100 calls at strike price of $120 which means that we were bearish on Apple's stock. Now, if the stock price goes above $120 then we will be having loss of the amount over and above $120. So, in order to hedge ourselves from bullish momentum of Apple stock, we can buy 100 shares today at current price of $110.

Now if the stock price goes above $120, the call buyer will exercise his call and we have to pay him amount over and above $120. However, the loss incurred by us on the call options will get adjusted by the Gain on our 'Apple stock holdings' that we bought for hedging purpose.

Hence, we hedged our risk bu buying 100 Apple stocks.

answered by: anonymous