Lesson 19 of 25 · 6 min
What happens to a hedge when the lender sells the shares
Protection outlives the position it protected, and what was a hedge becomes a directional bet nobody placed.
A hedge is a relationship between two positions, and a liquidation dissolves one side of it without touching the other. What remains is not a smaller hedge. It is a different position altogether.
Take 8,000 shares of a large-company stock at $63.75, worth $510,000, wrapped in a collar as Track 7 describes: 80 long put contracts struck at $55 and 80 short call contracts struck at $75, each contract covering 100 shares. The account's total collateral value is $1,120,000, the threshold is 62 percent, and the balance is $822,000. The permitted balance is $694,400, so the shortfall is $127,600 and the sale required is $127,600 ÷ 0.38 = $335,789.47.
In shares that is $335,789.47 ÷ $63.75 = 5,267 shares, and a lender selling in round lots rounds up to 5,300, realising $337,875. The share position is now 2,700, which covers 27 of the 80 short calls. The other 53 contracts cover nothing.
Read what that means. Before the sale, a rally above $75 cost nothing net: the calls capped the gain on shares that were held. After the sale, a rally to $88 costs 53 × 100 × ($88 − $75) = $68,900 with no offsetting shares behind it. The 53 surplus puts invert the same way in the other direction: they now pay out on a decline in a stock the account no longer holds, which is a position the borrower never chose to take. The hedge was symmetric around a share position that no longer exists.
Options are separate contracts, not attributes of a holding. Selling the shares does not close them, cancel them, or reduce their size.
Key terms
- Collar
- A long put and a short call held against a share position, capping both the loss and the gain within a range.
- Uncovered short call
- A short call with no underlying shares behind it. Its loss grows with the price and has no offsetting gain.
- Orphaned hedge
- An option position whose underlying holding has been sold, leaving a standalone directional exposure.
Worked example
From a collar to an uncovered position
8,000 shares at $63.75, 80 puts at $55, 80 short calls at $75. Collateral $1,120,000, threshold 62 percent, balance $822,000.
- Shortfall
- $127,600
- Sale required
- $335,789.47
- Shares sold, rounded to lots
- 5,300
- Shares remaining
- 2,700
- Uncovered short calls
- 53 contracts
- Cost of a move to $88
- $68,900
$822,000 − ($1,120,000 × 0.62).
$127,600 ÷ 0.38.
$335,789.47 ÷ $63.75 = 5,267, rounded up.
Covers 27 of 80 short calls.
5,300 shares of exposure.
5,300 × ($88 − $75).
A cure of $337,875 converted a capped position into an uncovered short call over 5,300 shares, with no transaction in the options at all.
Check yourself
You hold 8,000 shares against 80 short call contracts struck at $75. The lender sells 5,300 shares to cure a shortfall. What is your exposure if the stock reaches $88?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.