Understanding Mark Waiters' Risk Aversion and Options Trading Strategies

B

In order to understand the impact of establishing a covered call position on CGF stock and a protective put position on HSD stock, let's break down the given options and analyze each one.

A. The HSD position will have a higher break-even price and less downside risk.

• A covered call position involves selling a call option on a stock that an investor already owns. By establishing a covered call position on CGF stock, Mark Waiters will receive premium income from selling the call option. This premium income reduces the break-even price of the CGF stock. Therefore, Option A is incorrect because the HSD position will not have a higher break-even price as a result of the covered call position. Additionally, the covered call provides downside protection as the premium income received from selling the call option can help offset potential losses if the stock price decreases. Hence, the HSD position would have less downside risk.

B. The CGF position will have a lower break-even price and more upside potential.

• As mentioned earlier, establishing a covered call position on CGF stock generates premium income, which lowers the break-even price of the CGF stock. Therefore, Option B is correct. The premium income received from selling the call option acts as a buffer against potential losses in the stock's price. However, it also limits the upside potential because if the stock price rises above the strike price of the call option, the investor will have to sell the shares at the predetermined price, missing out on further potential gains.

C. The HSD position will have lower upside potential and less downside risk.

• The protective put position involves buying a put option on HSD stock to limit the downside risk. If the HSD stock price declines, the put option provides the right to sell the stock at a predetermined price, known as the strike price. This limits the potential downside risk of the HSD position. Therefore, Option C is correct. However, the protective put also limits the upside potential because if the stock price increases, the investor does not participate in the full extent of the price appreciation beyond the strike price.

In summary, after establishing the covered call position on CGF stock, the CGF position will have a lower break-even price but limited upside potential. On the other hand, after establishing the protective put position on HSD stock, the HSD position will have limited upside potential but less downside risk. Therefore, the correct answer is B. The CGF position will have a lower break-even price and more upside potential.