An investor has long exposure to the risk of the asset underlying an option when taking a:
A) short position in a put option
B) short position in a call option
C) long position in a put option
I answered B because my understanding of long exposure is that if the underlying asset appreciates, the position that bears the most risk would be a short call, as you can have infinite losses as the underlying appreciates.
The correct answer is A. The rationale is that “by taking a short position in a put option, the investor has long exposure to the risk in the underlying asset. Because the value of a put option decreases when the price of the underlying asset increases, the value of a short position in a put increases when the price of the underlying increases.”
I would assume that my interpretation of long exposure is inaccurate based on the answer so would someone explain what this question is actually asking/measuring regarding exposure?
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The question is asking which of the three positions gives long exposure to the underlying asset. Long exposure meaning (in a simple way to think about it I suppose) that your position in the option will benefit when the price of the underlying asset rises. Of those three options, only the short put position would benefit from an increase in the price of the underlying asset.
If you remember the delta values for long/short call/put positions, it might be easier to see this:
Long put = negative delta
Short call = negative delta
Short put = positive delta
Long call = positive delta
Option positions with positive delta carry long exposure to the underlying asset. Hope that helps?
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Yes - simply put Long Exposure = You stand to gain if the price of the underlying increases.
If you short the put = you are selling the put. If you sell the put and the stock price goes up, the put never gets exercised and your gain is whatever you sold the put for.
If you short the call = you are selling the call. If you sold a call option, and the price of the underlying increases, the call would get exercised and you will need to pay out the delta between the exercise price and the increased price of the underlying.
Ah, I read that as which position has exposure (i.e. not-covered) if the underlying asset increases, which I answered as A. I didn’t interpret it as the investor wanting to replicate a similar exposure of long the underlying.
Makes much more sense and seems obvious now that I see what they are actually asking. Thanks!