E. Option Trading Strategies (continued)

• b. Buying call options to limit risk
  • Investor dislikes the risk of buying IBM and watching it go down in value. Therefore, Investor purchases IBM 50 call at $5 and puts remaining $ in risk-free securities. Hence, given the same $5,000, the Investor buys call and puts $4,500 into R securities.
  • Example: If IBM goes to $60, the Investor can buy or exercise the option to net $1,000 plus interest from R investment. If IBM stays at $50 or falls below, the investor has lost his option premium which is partly offset by interest income.

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