Chapter 05 · Section 5.1

Hedging a Long Spot Position with a Long Put

Hedging a Long Spot Position with a Long Put

              Long Spot Position    Long Put     Combined

Declining     practically                              
prices:       unlimited             exercise     limited
              loss                               lost

Increasing    unlimited             expire       unlimited
Prices        profit                or sell      profit

The hedger:- has obtained a protection against decreasing prices.- still has the possibility of profitting from increasing prices.

N.B. "Practically" unlimited is to say here that the maximum loss is the price paid for the underlying asset.