Roland Cad owns a portfolio of large capitalization stocks. He has a positive long term outlook for the stock market, but Carl is worried about the possible effects of recent changes in monetary policy. Carl would like to protect his portfolio from any sudden declines in the stock market, without selling his holdings. The most likely way for Carl to achieve his objective of limiting the downside risk of his portfolio is to:
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A. B. C.B
To protect his portfolio from sudden declines in the stock market without selling his holdings, the most likely strategy for Carl is to sell put options on the S&P 500. Option contracts give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price (known as the strike price) on or before a specific date (known as the expiration date).
By selling put options, Carl is essentially taking on the obligation to buy the underlying asset (in this case, the S&P 500) at the strike price if the option holder decides to exercise the option. In return, Carl receives a premium (the price of the option) from the buyer of the put option.
Selling put options can help Carl limit the downside risk of his portfolio because it provides him with a certain level of protection. If the stock market declines and the S&P 500 drops below the strike price of the put options he sold, the option holders may choose to exercise their options and sell the S&P 500 to Carl at the strike price. In this case, Carl would have to purchase the S&P 500 at the strike price, but he would have the benefit of having received the premium from selling the put options, which would partially offset his losses.
It's important to note that selling put options does come with potential risks. If the stock market experiences a significant decline, Carl may still incur losses even after considering the premium received. Additionally, if the market rallies, Carl may miss out on potential gains because he is obligated to buy the S&P 500 at the strike price even if it is higher than the market price.
The other options presented, selling an S&P 500 futures contract and buying an S&P 500 forward contract, are not as suitable for Carl's objective. Futures and forward contracts are agreements to buy or sell an asset at a future date for a specified price. Selling a futures contract or buying a forward contract would expose Carl to the full downside risk of the S&P 500 without providing any premium or limited protection in case of a decline.
Therefore, selling put options on the S&P 500 is the most likely strategy for Carl to limit the downside risk of his portfolio while retaining his holdings in the stock market.