Question

An investor owns 10,000 shares of a stock paying no dividend and currently trading at $160 per share. The stock has a volatility of 20% and the current risk-free rate is 2.5%. Three months from now she would like to liquidate the shares to purchase an investment property for $1,500,000. She is concerned that if the stock price falls over the next three months, she would not be able to buy the property. On the other hand, she does not want to sell her shares now since there is also the possibility that the stock price will increase over the next three months and so she would miss out on such gains. How can she mitigate against this risk? Note that since the portfolio has a single stock, Markowitz portfolio theory does not directly apply.

Answer 1

She can hedge her Portfolio by option strategy or futures.

She can sell a call option at $180 and use the proceeds to buy a Put option at $150.
By this strategy, she will be protected when the stock price falls.

The loss of this strategy is that she won't be able to benefit if the stock price goes above $180.

She can go short on futures at $170. Such that if the stock price is below $170 she will benefit from this.
The loss of this strategy is that she won't be able to benefit if the stock price goes above $170.

She can reduce/ mitigate risk through these strategies.