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Answer: Sell out-of-the-money puts
**Correct answer: D) Sell out-of-the-money puts** This is the best fit because: - Eddie is **bullish long term**, so he is willing to own the stock eventually. - He wants a **lower entry price** than the current market price. - He prefers **upfront cash flow**, which means he would like to **receive option premium** now. Selling an **out-of-the-money put** matches all three preferences: - It generates **premium income upfront**. - If assigned, he may have to buy the stock at the strike price, which is **below current market price**. - It is a bullish-to-neutral strategy, consistent with wanting to own the stock only if it falls. Why the other choices are less suitable: - **A) Buy out-of-the-money calls**: bullish, but requires paying premium upfront, not receiving cash flow. - **B) Sell in-the-money calls**: receives premium, but is not a good way to express a desire to buy the stock later at a lower price. - **C) Buy in-the-money puts**: bearish and requires paying premium. So the best trade is **selling out-of-the-money puts**.
Author: Manit Arora
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Question 21.8.1
Eddie is a retail investor who believes that Starbucks (ticker: SBUX), which is a dividend-paying stock (its dividend yield is currently ~1.75%), is an attractive long-term business. He would like to own SBUX shares over a long horizon (i.e., at least three years), but at the same time, he considers the stock to be currently overpriced by ~15% due to the market's temporary euphoria. Specifically, SBUX trades today at $115.00, but Eddie wants to buy the stock only if its price drops below $100.00 because he believes its current intrinsic value is $100.00. Under this view, Eddie has a long-term bullish view, but he wants a lower entry price if it becomes possible in the near term due to a market dip or correction. This is why he will not buy the stock today. Finally, rather than make an initial investment, he prefers to receive upfront cash flow.
Eddie wonders if a naked option trade can express his view. Given his views and preferences, among these naked option trades, which of the following option trades is best for him?
A
Buy out-of-the-money calls
B
Sell in-the-money calls
C
Buy in-the-money puts
D
Sell out-of-the-money puts
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