Cl,apter 4: Other Call Buying Strategies 119 
the short seller can cover his short by exercising the long call and buying stock at 40. 
Thus, the maximum risk that the short seller can incur in this example is the 3 points 
paid for the call. Table 4-1 and Figure 4-1 depict the results at expiration from uti­
lizing this strategy. Commissions are not included. Note that the break-even point is 
37 in this example. That is, if the stock drops 3 points, the protected short sale posi­
tion will break even because of the 3-point loss on the call. The short seller who did 
not spend the extra money for the long call would, of course, have a 3-point profit at 
37. To the upside, however, the protected short sale outperforms a regular short sale 
if the stock climbs anywhere above 43. At 43, both types of short sales have $300 loss­
es. But above that level, the loss would continue to grow for a regular short sale, while 
it is fixed for the short seller who also bought a call. In either case, the short seller's 
risk is increased slightly by the fact that he is obligated to pay out the dividends on 
the underlying stock, if any are declared. 
A simple formula is available for determining the maximum amount of risk 
when one protects a short sale by buying a call option: 
Risk = Striking price of purchased call + Call price - Stock price 
Depending on how much risk the short seller is willing to absorb, he might want to 
buy an out-of-the-money call as protection rather than an at-the-money call, as was 
shown in the example above. A smaller dollar amount is spent for the protection 
when one buys an out-of-the-money call, so that the short seller does not give away 
as much of his profit potential. However, his risk is larger because the call does not 
start its protective qualities until the stock goes above the striking price. 
Example: With XYZ at 40, the short seller of XYZ buys the July 45 call at ½ for pro­
tection. His maximum possible loss, if XYZ is above 45 at July expiration, would be 
TABLE 4-1. 
Results at expiration-protected short sale. 
XYZ Price at Profit Call Price at Profit Total 
Expiration on XYZ Expiration on Call Profit 
20 +$2,000 0 -$ 300 +$1,700 
30 + 1,000 0 - 300 + 700 
37 + 300 0 - 300 0 
40 0 0 - 300 300 
50 - 1,000 10 + 700 300 
60 - 2,000 20 + 1,700 300