Gapter 4: Other Call Buying Strategies 131 
FIGURE 4-3. 
Reverse hedge using two strikes (simulated combination purchase). 
C: 
~ ·5. 
in 
~ 
l/l 
.3 
0 
i.l::-$350 
e a. 
SUMMARY 
40 
Stock Price at Expiration 
The strategies described in this chapter would not normally be used if the underly­
ing stock has listed put options. However, if no puts exist, or the puts are very illiq­
uid, and the strategist feels that a volatile stock could move a relatively large distance 
in either direction during the life of a call option, he should consider using one of the 
forms of the reverse hedge strategy - shorting a quantity of stock and buying calls on 
more shares than he is short. If the desired movement does develop, potentially large 
profits could result. In any case, the loss is limited to a fixed amount, generally 
around 20 to 30% of the initial investment. Although it is possible to take follow-up 
action to lock in small profits and attempt to gain on a reversal by the stock, it is wiser 
to let the position run its course to capitalize on those occasions when the profits 
become large. Normally a 2:1 ratio (long 2 calls, short 100 shares of stock) is used in 
this strategy, but this ratio can be adjusted if the investor wants to be more bullish or 
more bearish. If the stock is initially between two striking prices, a neutral profit 
range can be set up by shorting the stock and buying calls at both the next higher 
strike and the next lower strike.