Chapter 05 · Section 5.1
Hedging a Short Position 1
Hedging a Short Position with a Long Call
Short Spot Long Call Combined
Declining practically expire
prices: unlimited or sell
profit
For falling prices, the combined position created gives:
a) Practically unlimited profit potential.
b) Limited profit potential.
The call gives the hedger the right, but not the obligation to buy the short asset.
With decreasing prices, the hedger can buy the short asset at a lower price than by using the option. He will therefore let the call expire or try to sell it in order to recapture any remaining time value.