An investor owns 1,000 Microsoft shares. The price is $28 per share. He is concerned about a possible share price decline in the next 2 months and wants protection. Buying ten July $27.50 put option contracts would give him the right to sell 1,000 shares for $27.50.
If the put premium is $1 ($100 cost per put)then the total cost of the hedging strategy would be 10 x 100 = $1,000.
This strategy guarantees that the shares can be sold for $27.50 per share during the life of the option. If the price of Microsoft falls below $27.50, the options can be exercised so that $27,500 is realized for the shares. When the cost of the options is taken into account, the amount realized is $26,500. If the market price stays above $27.50, the options will expire worthless.
Figure 1.4 shows the net value of the portfolio (after taking the cost of the options into account) as a function of Microsoft’s stock price in 2 months. The dotted line shows the value of the portfolio assuming no hedging.
The graphs below are those that I have been studying and as you can see the shape of the graph of the exercise corresponds to the shape of a long call position.
Can somebody explain why the graph looks like this? I understand the explanation of the exercise and how it's helpful to hedge using a put strategy but I think that the shape of the graph (the solid Hedging line) is the shape of a long CALL option payoff. Shouldn't it be that of a long put option payoff since it is a long put?