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 308

Suppose you had sold 2 FMJ contracts for $2 premium with 20 days to go with Ford trading at $50 at the time. Just like writing calls, three scenarios could happen:

  • You could settle those contracts. If within 10 days Ford stock has fallen to $40, those FMJ contracts may now go for $11 premium ($10 intrinsic + $1 time). To settle your contracts you would have to pay $2,200 to buy 2 FMJ contracts. Considering that your proceeds from the original sale was $400, your net loss would be $1,800. At this point you may say why not wait until expiration so you end up with less loss? If at expiration Ford still is at $40, those 200 shares will be put to you at $50 per share. That means you would have to buy them at $50 and then you may decide to sell (unload) them at $40 for a loss of $2,000. Counting the $400 proceeds, you net loss would then be $1,600 rather then the $1,800 loss if you had settled them earlier. True, but what if Ford had continued to fall below $40. Then you may be looking at a bigger loss than $1,800 come expiration date. Of course Ford could bounce back from the $40 price, making you wish you hadn't panicked and settled those puts. I wish I had a good answer for you but these are the complexities of options. You must look at your individual situation and based on your speculation decide whether you should cut you losses at a point or ride it out in the hopes of less losses or even profits. If Ford indeed turned around and went to $52 within 10 days, those FMJ options might now go for a $1 premium (probably less but let's keep the example simple). Now you can go ahead and buy 2 JMJ contracts for $200 to settle your short position. In this case your net profit would be $400 (original proceeds) - $200 = $200. So depending on where the stock stands you may have a profit or loss (or break-even) when you settle your contracts.

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Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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