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Short Position, Calls, Puts, & Portfolio Insurance

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1. If you have a short position on a call option with a strike price of $53.50 and the stock price is $55.50 at the expiration date and the holder of the option exercise the option, what will be the result to you?

a. You can cancel the transaction because the strike price is less than the stock price.
b. You can buy the stock for $53.50 and sell it for $55.50 and make a profit of $2.00.
c. You will have to purchase the stock at the market price ($55.50) and sell the stock at the strict price for a loss of $2.00.
d. You can renegotiate the strike price.

2. Describe call and put options, and explain why someone would want to deal in options rather than in the underlying asset.

3. Portfolio insurance can be arranged in several ways. An investor can purchase a call and a protective put to guard against a greater than expected decline in the value of the underlying security. An investor can also buy actual insurance that pays the investors if the investment does not result in an expected return. An 'investor' can even buy insurance that will pay if an investment that the 'investor' did not actually make does not result in the expected return. All of this is presently perfectly legal, but does it make any sense that I can buy insurance on a risk that I do not actually have because I did not actually make the investment that is insured?

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Options Solutions

1) A call option is the right to buy stock at a certain price at a future date. So the holder of the option can buy at $53.50 when the true value is $55.50. The holder thus pays you $53.50 for the option, and you give the holder stock worth $55.50. So the holder of the option makes $2 on this transaction, and since you're short the option, you lose $2. So the answer is c).

2) A call option is the right, but not the obligation, to buy an underlying asset at a certain price at a particular future date. A put option ...

Solution Summary

The solution provides 3 option problems that include the short position, calls, puts and portfolio insurance.