Question

pls do not handwrite the answer, this is for easy reading thank you! (except the equation)

Discuss ways in which a put or a call option may be used in hedging and speculation, with examples.

Answer 1

Put option means the right to sell a certain number of security by the option holder before the maturity date.

Call option provides the right to the option holder to buy a specific number of security before maturity date.

Both type of options whether it is a call option or a put option is used to hedging and speculation purpose and it can be reflected as below-

Call option can be used to hedge a position when a short seller had already shorted a particular number of security, and he believes that the share should go down but he also had bought a call option to protect himself against any upside movement of the stock. In case, if the stock started to move against the expectation of the short seller on the way upside,he will lose his money on the short position but he will get through call option because he have hedged the position through a call option.

It can be exampled when a short seller had shorted 100 share of a company at $100 each, and he expects the price to go to 90.He has also bought a call option of $105 .if the stock started to move up against his expectation to $ 105,he will lose money on the short position, but he will gain money on the call option.

Put option can be used to hedge a position if an option holder is bullish on certain security, and he is already holding a portfolio and he wants that portfolio to make higher returns as he expects the share to go upside. In this case, he will hedge himself with buying a put option which will protect him from the downside risk, when the stocks will started to move on the way down side, he will lose on his portfolio position but he will gain through his put option and it will minimise his overall loss.

It can be exampled when shareholder is holding 100 shares of a security for 100 each, and he expects it to go to 110. He has also bought a put option of strike price 95 so the stock if started to go down to 95 against his expectation he will lose money on the the share holding position but he will gain his money on the put option.