Question

You are long the S&P 500 index (500 US stocks). You are afraid that a tariff war will hurt the value of the US stocks. Should you buy a put or call on the S&P 500 to hedge your exposure?

Multiple Choice

A. Sell a put

B. Buy a put

C. Buy a call

D. Do nothing

E. Buy a put and buy a call (the more options the better)

Answer 1

Risk of tariff war creates chances of hurting the stocks prices and prices may fall, which may lead to losses for us as we are long (buy) on a stock.

Let us analyse each option:

A) Sell a put: Selling a put which make us buy option when buyer of the option exercises it. So if prices fall, then buyer of the option will sell and we would need to buy those at higher prices which will be a loss for us. Hence, NOT a option for hedging our state.

B) Buy a put:

Buying a put option gives us the option to sell stock at pre-determined prices if share price falls. This suits our situation. If prices are falling and we can sell our stocks (already long) then we can cover our losses (might be in profit also). Hence, YES for this strategy to hedge our position.

C) Buy a call:

Call options gives us an option to buy stocks at a particular price. If prices are already falling due to tariff war, we can already buy at low prices and hence no need of buying this option. Hence, NO for this strategy to hedge our situation

D) Do nothing:

We are not hedging in this strategy and hence, a NO for this strategy.

E) Buy a put and buy a call

We have already analysed that buying a call option is not giving any benefit to us. However, buying a put option is good for hedging our situation. Hence, using this strategy we will be paying premium for 2 options, out of which 1 option (call) will not be exercised if prices fall. Hence, NOT a good strategy for hedging our situation

SO only correct answer is B)

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