284 
FIGURE 18-1. 
Straddle purchase. 
C: 
.Q 
I!! ·a. 
X 
w 
ro $0 en en 0 
..J 
0 
-e a.. 
-$500 
Part Ill: Put Option Strategies 
Stock Price at Expiration 
chase is superior to the reverse hedge, however, and where listed puts exist on a stock, 
the reverse hedge strategy becomes obsolete. The reasons that the straddle purchase 
is superior are that dividends are not paid by the holder and that commission costs 
are much smaller in the straddle situation. 
REVERSE HEDGE WITH PUTS 
A third strategy is equivalent to both the straddle purchase and the reverse hedge. 
It consists of buying the underlying stock and buying two put options. If the stock 
rises substantially in price, large profits will accrue, for the stock profit will more 
than offset the fixed loss on the purchase of two put options. If the stock declines in 
price by a large amount, profits will also be generated. In a decline, the profits gen­
erated by 2 long puts will more than offset the loss on 100 shares of long stock. This 
form of the straddle purchase has limited risk as well. The worst case would occur 
if the stock were exactly at the striking price of the puts at their expiration date - the 
puts would both expire worthless. The risk is limited, percentagevvise and dollar­
wise, since the cost of two put options would normally be a relatively small per­
centage of the total cost of buying the stock. Furthermore, the investor may receive 
some dividends if the underlying stock is a dividend-paying stock. Buying stock and 
buying two puts is superior to the reverse hedge strategy, but is still inferior to the 
straddle purchase.