Note this post is more suited for those who wants the praticality of hedging. If you are struggling with derivatives, DON’T READ THIS FURTHER BECAUSE IT MAY CONFUSE YOU.
Mock, Exam 2 P.M session Question 109-114.
Honestly, irks me how they say the hedge of a long stock can be done with short calls. When advising clients I don’t see that as hedging. What it is doing is effectively taking away the upside of the stock for a premium upfront. Best case scenario here for the position of the long stock is it never reaches strike price. Downside is not covered in this ‘hedge’. If prices goes down, the stock is still exposed. The 2 legs to this structure is honestly something that needs to be seen seperately. To truely hedge the stock, go long put. To make it zero-cost, short call with the long put.
Also using different option maturities for a ‘hedge the exposure for 90 days’ will cause maturity mismatch.
On a side matter, note how in Economics they switch around the base and term currencies. USD/GBP, and then USD/JPY. In the currency market, the first currency is always the base unit (1 unit of term), and GBP is quoted as a standard - GBP/USD ( meaning how many USD can one GBP buy). If I quote USD/GBP, it means how many GBP can one USD buy. Again, knowledge of praticality is dangerous here because if I use the global understanding of how currencies work, I’ll be getting my answers wrong