Question

Suppose that the American Congress (AC) passes a bill that prohibits the short selling of stocks, which makes impossible for investors to have profit when stock prices go down. However, AC doesn’t impose any restrictions on option trading. As a student of ADM2352, what is your advice to the investors who want to be short in a particular stock? In other words, provide a strategy on how to accomplish the equivalence of a short sale by using options and borrowed capital. Create a payoff table of the strategy, to back your answer.

Answer 1

Here investor can buy put option. Put options gives it's holder right to sell the underlying asset at specified price at end of the contract period. To buy put option one has to pay premium.

Table showing payoff

Assume strike price is 50, premium is 2 and interest rate on borrowing is 10% and contract is for 1 year.( Here borrowings will be equal to premium amount)

Price at exipry	Profit/loss on Put Otion whith strike price @ 50,	premium paid	interest @10% on premium	Net profit
40	10	-2	-0.2	7.8
41	9	-2	-0.2	6.8
42	8	-2	-0.2	5.8
43	7	-2	-0.2	4.8
44	6	-2	-0.2	3.8
45	5	-2	-0.2	2.8
46	4	-2	-0.2	1.8
47	3	-2	-0.2	0.8
48	2	-2	-0.2	-0.2
49	1	-2	-0.2	-1.2
50	0	-2	-0.2	-2.2
51	-1	-2	-0.2	-3.2
52	-2	-2	-0.2	-4.2
53	-3	-2	-0.2	-5.2
54	-4	-2	-0.2	-6.2
55	-5	-2	-0.2	-7.2
56	-6	-2	-0.2	-8.2
57	-7	-2	-0.2	-9.2
58	-8	-2	-0.2	-10.2
59	-9	-2	-0.2	-11.2
60	-10	-2	-0.2	-12.2