On the same day, a customer buys 100 shares of ABC at $40 and sells short 100 shares of XYZ at $50. The customer then buys 1 ABC Jan 40 put @ $4 and 1 XYZ Jan 50 @ $5. XYZ rises to $60 and the customer exercises the call. ABC falls to $25 and the customer exercises the put. The net gain or loss on all transactions is:
a. $500 loss
b. $900 gain
c. $900 loss
d. breakeven

C) $900 loss

Explanation:

The customer shorts stock because he thinks the market for ABC will go down. However, he also wants to protect himself from unlimited loss potential if the market should rise, so he buys a call which gives the right to buy stock at the strike price. Here, the market goes up suddenly, and the customer exercise the call. The stock that was sold originally for $40 is purchased for $50 for a 1 point loss on the stock. Since $9 was paid in premiums, the total loss is 9 points or $900 for the 100 shares. Therefore, the net loss on all the transaction is $900. The customer lost $500 premium for call lost and $400 premium for the put lost.