Question

You currently own stock in Wayne Enterprises. You are worried that the stock will fall in the near term due to risky lifestyle choices of its CEO. You do not want to sell the stock, but would like to insure against a sudden drop in the stock's value. How could you achieve this outcome using options?

Answer 1

Answer:

You own stock in Wayne enterprises and you want to insure against sudden drop in share price. Methods to protect from sudden drop are as follows:

1. Buy a put option : Put option is a contract which gives the right to sell the shares. It helps to hedge against the drop in share price. In above case, we can buy put to hedge the risk of drop in share price. In this case, we need to pay the premium to buy the put options

2. Sell a call option: Call option is a contract which gives the right to buy the shares but we have short sell the call option to protect the downside of the stock price. In above case, we are already long on stocks so we can sell call options to safegurard the drop. In this case, the call seller will receive the premium. However, if stock price goes up, call seller will bear the loss due to increase in share price.

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