How Stock Options work. Hedging in the stock market, through a Dave Portnoy story.

So it turns out that Dave Portnoy bought $7M worth of Amazon stock (Yes, stock) on April 30th, expecting sensational earnings from the Company’s Q1 results. The idea being he wanted the stock to break ~$3000, and he could collect profits.

He didn’t say by when.

Barstool Sports’ online-asset ‘Barstool Rundown’ wherein their hosts discuss a weekly wind-down, they mention wanting to ‘hedge’ against the position but not doing it because they didn’t really know what that means. A common problem.

And a great opportunity to quickly understand how Stock Options work, in case you’ve been struggling with it. He’s bought about 30,000 units of stock in Amazon for about $7M @ $2400. Now, ‘a hedge’, in his case means he wants to protect against the downside and minimize his losses if the stock price goes down.

Options would have helped him hedge in 2 ways here.

A) He might have bought 300 Put contracts.

After buying 30,000 shares, he can buy 300 contracts (Buy-to-Open) at say, a $2300 strike. As the stock price went down post-earnings, the value of his put contracts would have gone up. After earnings, he could have sold the contracts for an amount roughly equal to what he lost on his stock position. Hence, he’d have ‘hedged’ his bet.

And then he can sell his stock position too, as he recovers almost all of his $7M from his bet that went wrong.

B) He might have sold 300 Call contracts.

After buying 30,000 shares, he might have sold 300 Call contracts (Sell-to-Open). His broker, say TD Ameritrade, will manufacture those contracts and sell it in the open market. It will then deposit proceeds from that sale into his account. Now, he has hedged his position ahead of the results. If the stock retreats, you keep the premium, hence nullifying his losses.

If the stock moves up and hits the strike at which he sold his Call contract, he’s simply required to sell his 30,000 stock units to the buyer of the contract. No harm done.



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