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 309

  • The options expire worthless - if Ford stock stays at or rises above $50 at expiration, those FMJ options would expire worthless and you would have a $400 profit from the proceeds.
  • The options are exercised - we covered this at the beginning of this section. If Ford is in fact below $50 come expiration, those 200 shares will be put to you. (i.e., you will have to buy 200 shares of Ford at $50 per share). In that case you would have a loss.

Now just like calls, you can write covered or uncovered (naked) puts.

Covered Puts - This means that you write put options against your short stock positions. If prior to writing the 2 JMJ contracts you had shorted 200 Ford shares (preferably at $50 or higher), you would be covering yourself against losses should Ford stock fall. How? This gets a little tricky, so pay attention. If you had shorted 200 Ford shares at $50 per share, you would have $10,000 in proceeds in your account. By writing those 2 FMJ contracts, you would receive $400. Now Ford falls to $40 and it is expiration time which means 200 shares of Ford will be put to you at $50. You can then use the $10,000 in your account to buy the 200 shares and you use them to cover the 200 shares you had originally shorted and you keep the $400. Simple, huh? Well not quite.

First of all if you hadn't written the put options at all you would have simply covered those 200 shorts at $40 per share and you would have pocketed the $2,000 remaining from the proceeds. But this is the profit you forego for having the insurance of covered puts. Second, let's look at the flip side. If Ford rises to $60, the FMJ contracts would expire worthless and you keep the $400, but those 200 shorts are now in jeopardy. If Ford continues to climb you may have to start covering your short position at a loss. (See the dangers of shorting in the stock chapter). So while from the put option standpoint you are in a good

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Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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