Question

How could a MNC decide whether to use a put or call option variant for risk management purposes? Provide a descriptive example for each situation.

Answer 1

A MNC has various positions running in their account to manage risk , now the question arises when to use which option to manage risk. a brief description is given below

CALL OPTION -

suppose a MNC has long position on running on a stock which expires after one month. now the business environment has changed and company has missed the estimates and want to protect the downside risk while carrying the invested long position . a simple process can be selling a call option by the company which -

  1. if market goes up - the long position will give profit while the call option writing will bear a small risk

2. if market remains constant - the long position will bear no profit no loss but the premium of call options will become zero and company will still yield profits by selling the call option higher and buying it back at zero even with no market movement.

3. if market goes down - the long position will bear losses but the equal amount of profit can be taken by profits of writing a call option.

PUT OPTION -

suppose a MNC has short position on running on a stock which expires after one month. now the business environment has changed and company has missed the estimates and want to protect the downside risk while carrying the invested long position . a simple process can be selling a put option by the company which -

  1. if market goes down - the short position will give profit while the put option writing will bear a small risk

2. if market remains constant - the short position will bear no profit no loss but the premium of put options will become zero and company will still yield profits by selling the put option higher and buying it back at zero even with no market movement.

3. if market goes up - the short position will bear losses but the equal amount of profit can be taken by profits of writing a put option.

THEREFORE BOTH CALL AND PUT OPTIONS CAN BE USED BOTH FOR HEDGING POSITIONS BY MNC