Question

You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit but you are troubled about the short run behavior of the stock market. An effective action on your part would be to a. Purchase a call. b. Utilize a bearish spread. c. Purchase a put. d. Purchase an index option. e. Utilize a bullish spread.

Answer 1

Here we know that we have an unrealized gain but we still want to give some time before we actually realize it in expectation of greater gains. But this entails a risk of losing some of the unrealized gain if the price of the stock goes down. To ensure this unrealized gain, we can purchase a put option with an exercise price of 32 so that if the stock goes down, we can exercise the put and ensure to receive the price of 32 but if the stock goes up, we have an option of not exercising it and therebey not limit our gains in case of an upswing.