You own shares of a stock and believe the stock price will increase in the future. However, you realize the stock price could decline and want to hedge that risk. Which one of the following option positions should you take to create the desired hedge?
A)buy a call
B)sell a call
C)buy a put
D)sell a put
E)none of the above

Question

Quizplus · Accepted Answer

Buying a put option gives the investor the right, but not the obligation, to sell the stock at a specified price (strike price). If the stock price does decline, the put option gives the investor the ability to sell the shares at the higher strike price, providing a hedge against potential losses. Selling a call option, on the other hand, gives the investor the obligation to sell their shares at the strike price if the stock price rises above that level – which may not be desirable if the investor believes the stock will continue to rise. Buying a call option does provide the investor the ability to profit if the stock price rises, but it does not provide protection in the event of a decline. Selling a put option gives the investor the obligation to buy the stock at the strike price if the stock price declines further – which may not be desirable if the investor wants to limit their risk exposure. Therefore, buying a put option is the best choice to create the desired hedge.

You Own Shares of a Stock and Believe the Stock