← Strategy LabLesson 9 · 4:04
Protective call
Summary
Use a protective call when you are short the shares and want a fixed, known worst case if the stock spikes. You short 100 shares at $100 and buy the $105 call for $1.58 a share, so your worst case is a loss of $658, and if XYZ went to zero you would make $9,842. You break even at $98.42.
Key terms
- protective call
- Shorting 100 shares and buying a call, which puts a ceiling on the loss if the stock rises until the call expires.
- shorting
- Borrowing shares, selling them, and hoping to buy them back cheaper later.
- ceiling
- The best result a capped position can reach, set by the sold call's strike.
- borrowing fees
- What your broker charges you to borrow shares while you are short them.
- time value
- The rest of an option's price, paid for the chance things get better before the end, and gone by the last day.
- break-even
- The stock price on the last day where you neither make nor lose money: strike plus premium for a call, strike minus premium for a put.
Check yourself
Answer each question to see why the right answer is right.
1. You short 100 XYZ at $100 and buy the $105 call for $1.58 a share. What is your worst case on the last day?
2. Where does the protective call break even?
3. XYZ sits at $110 and days pass with nothing else changing. What happens to your result?
4. XYZ ends at $90 on the last day. What is your result?
5. In the protective call, what does the bought $105 call do?
Finished the video and the quiz? .