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Offsetting a sold put without short stock

Question

You have written a put on a stock. You cannot short the stock and cannot trade any other options. How can you hedge?

Short answer

Sell forwards or futures on the stock (or on a closely correlated index). A written put gains when the stock rises and loses when it falls, i.e. it has positive delta, so you need a position with negative delta. A short futures or forward position supplies that without borrowing shares; rebalance the number of contracts as the put's delta changes. Selling shares of the stock you already own also works.

Adapted from Crack, Heard on the Street, Q2.43, p.30; question and answer rewritten by SelfMadeQuant.com.

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