Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 295

only in reverse. The better news is that all of the concepts we covered so far about options also apply to put options. Simply put (no pun intended), a put option gives the right (but not the obligation) to the holder to sell a number of the underlying stock's shares (depending on the number of contracts) at the strike price prior to the option's expiration date. The difference is simple but subtle. Instead of the right to buy in call options, we are now talking about the right to sell. That's why put options work the same as call options, only in reverse. So while the holder of a call option is hoping for a rise in the underlying stock price, the holder of a put options is hoping for a decline in the underlying stock price. Let's get back to our Ford example.

Ford stock is trading at $50 (what else is new?) and you are expecting it to decline. How would you position yourself to profit from this? For one you could short the stock. Let's say you short 200 shares of Ford at $50. In order for you to do that you must have a margin account and your broker may require you to have equity (either in cash or stocks) up to half the value of the stocks you are shorting ($5,000). Previously we discussed the dangers of shorting (remember the unlimited loss potential). Your broker must make sure that you are not going to skip town should things go sour with your short position, thus the margin requirement works like bail. Shorting 200 shares of Ford at $50 dollars will give you $10,000 in cash. Now suppose your assumption was correct and Ford did indeed take a dive to $40. At this point you may want to cover your short position by buying back the 200 shares at $40 per share for a total of $8,000. Your net profit would then be $10,000 (proceeds from the short)-$8,000 (cost to cover) = $2,000.

Unlike buying a stock, it is difficult to determine a return on investment when it comes to shorting. After all you really didn't put up any of your own money to short the stock, instead you borrowed the shares. But for the sake of argument let's say the initial margin of $5,000


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    Bonds Futures Stocks Options
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