Call and Put Options

[hsuwang]

"If you have a short stock position, the simplest hedges are to buy a call option or to sell a put option. Buying a call option hedges a short stock position exactly the same way buying a put hedges a long stock position,
and selling a put hedges a short stock position exactly the same way selling a call hedges a long stock position."

I see how "Buying a call option hedges a short stock position exactly the same way buying a put hedges a long stock position",

but this last part "selling a put hedges a short stock position exactly the same way selling a call hedges a long stock position" is what confuses me.

If you are in a short position, how will selling a put option benefit you? This means if the stock price goes up, in which you don't want for a short position, the buyer of your put option won't execute the option either because he/she can sell the stock at a higher market price.

Maybe it's just that I'm not getting the concept right.. can anybody help me on this. Thank you very much!!

 

[sripadarajesh]

I think the word "Exactly" is misleading I guess!

When you have short stock position and if you sell a put, it does hedge your position, but only upto an extent! It is not exactly similar to buying a call option and hedge your position.

Selling a put partly hedges your postion, if the market goes up upto a particualr level (where, the net difference in postions is equal to the preimum that you received on Selling the put options).

If the market still moves upwards beyond this point, then you start losing the money on your short stock positions, since there is potentially unlimited level to which a stock can raise. Potential loss on short stock postion is unlimited and gains on Selling a put is limited to the premium that we receive.

Cheers!

 

[David Harper CFA FRM]

Jack,

If that's from our material, can you source so i can correct the *error*?
I agree with Rajesh's great explain.
And, as he suggests, "exactly" is wrong here. Further, neither writing a covered call nor the covered put (i.e., writing a put against a short stock position) are hedges. These are, to my knowledge, both income strategies, and agreeing with your confusion: both with unlimited downside. Rajesh salvages the only conceivable "hedge" (misnomer) that occurs in the narrow trading range near the put strike price. Hull Figure 10.1.(d) illustrates the covered put and justifies your confusion...

Thanks, David