Question

To hedge a long stock position in XYZ, you can do all the following EXCEPT:
Buy at the money XYZ puts to open
Buy in the money XYZ puts to open
Sell out of money XYZ puts to open
Sell out of money XYZ calls to open

Answer 1

Suppose Current stock price of XYZ = $100

Risk of long stock position is the loss when stock price falls below the purchase price. Fall in stock price is hedged by buying Put option (ATM, or ITM) So we do 1st and 2nd option to hedge long stock position.

Sell OTM XYZ puts:

If S=$100 & X = $80 for put put option. Put option is OTM. Receive upfront premium as long as the stock price is above strike. If stock price falls below exercise price ($80) then the Put buyer will exercise the Put and the downside risk is unhedged. So one will not Sell OTM puts if he wants to hedge the long stock position.

Sell OTM XYZ calls:

If S=$100, X = $130 for call option. Selling the OTM call option implies that the writer of the call option has bearish view on the stock and so benefits from the price fall by the upfront premium received for writing OTM the call option. So we do short the OTM call and benefit from price fall.

Answer: We do all the following except Selling OTM XYZ Puts.