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Short position protection

(Part 1) explain how a short position can be protected with options; use examples

(Part 2) comment on how leverage works in purchasing call options.

Solution Preview

Options and Mitigation (see the attached file).

(Part 1) Explain how a short position can be protected with options; use examples

To answer (Part 1) I give some definitions to help understand:

Short Position is the sale of an asset, expecting the value to drop. Asset being: security, commodity or currency. A short position means you are the seller. You can have a short call position and you are required to deliver at the agreed price.
Call: offer to BUY.
Put: offer to SELL.
Strike Price 'CALL: agreed price up to expiry date. BUY
Strike Price 'PUT': agreed price by seller. SELL
Market Price: price of the security at time of exercising the call.

As a seller, a short call means you have to deliver 100 shares at the strike price. If the market price has increased you will lose as you must sell at the strike price which is lower. If the price has decreased, you will gain as you can sell at the strike price which is higher than the market price.

As a buyer, a short position means you have to buy 100 shares at the strike price. If the market price has increased you will gain as you will buy at the strike price which is lower. If the price has decreased, you will lose as you can buy at the strike price which is ...

Solution Summary

The solution provides a short position protection.

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