CFA Practice Question
A technical analyst strongly believes that the price of Digiscam, Incorporated common stock will fall throughout the course of the next few months, and wishes to build a position to profit from this decline. Which of the following strategies is the most appropriate for this investor?
A. Long, "in-the-money" puts
B. Short, "out-of-the money" puts
C. Naked, "at-the-money" puts
Explanation: In this example, the investor is wishing to profit from the decline in the price of Digiscam, Inc. common stock. The technical analyst should employ the use of long put contracts.
User Contributed Comments 13
| User | Comment |
|---|---|
| Will1868 | wouldn't be cheaper for the investor to build is long position "at the money" as opposed to "in the money"? |
| SDog | I agree, more upside if he really does "strongly believe". |
| mark98007 | Yes; choice C is correct here if his "strong belief" is worth anything |
| george2006 | C is wrong.It is shorting puts. |
| dimanyc | the owner of the naked put hopes for the price to rise |
| egghead | I guess naked means without underlying asset thus it's ittributed to the writer of the put who is obviously short |
| cocomilk | C is wrong. naked means uncovered position, which is used to describe shorting call/put. |
| dlukas | Tricky. Naked = short with no underlying (or other offsetting position) |
| djread | Can you not hold a long "naked" position in a put? i.e. buy a put and not hold the underlying |
| Borsh | long "in the money" put... you buy (long) the right to sell (put) to a loser at a price that is expected to be higher than market before expiration. |
| kamcooler | Anyone who has ever traded options would understand this as a position in the underlying stock vs an options position. |
| Mollka24 | Wonder, why we consider short put (out of the money) - not. If investor owns a stock and longs a put with fixed strike, his profit will be limited by X-S less option premium. But if he does not own a stock rightaway (we do not know exactly if he already has long stock) he will also have to acquire long stock (protective put). Also key is hedging for such strategy, not maximizing profit from decline. All income from option will be offset by capital loss in long stock. But selling put out of money will actually have unlimited profit equal to number of short puts multiplied by premiums (theoretically suppose that there is temporary demand for such out of money options). Any ideas? |
| harrybay | You can also be long naked on puts. |