You own $75,000 worth of stocks, and you are worried the price may fall by year end in 6 months. you are considering using either puts or calls to hedge the position. given this, which of the following statements is (are) correct?

i. one way to hedge your position would be to buy puts
ii. one way to hedge your position would be to write calls
iii. if major stock price declines are likely, hedging with puts is probably better than hedging with short calls

a. i only
b. ii only
c. i and ii only
d. i, ii, and iii

The answer is D. I, II, and III

Explanation:

As an investor buy a puts, he has the right to sell at exercised price stipulated in the put contract, which hedge the investor from the risk that the price in 6-month time will be going below the exercised price ( because he is able to sell the stock at exercised price through put option he holds). So, I is correct.

II. is correct because be writing a calls the investor has the obligation to sell at exercised price, given the market price fall below the exercised price in 6-month time, the call will not be exercise; however, he will be compensate by the premium from writing a call.

III. is correct because a short call will include holding the underlying asset, thus; once the major stock price decline happens, the profit from the strategy will be deducted due to decrease in underlying'asset price. Thus, in this situation, hedging with puts is probably better.