How to Profit From Declines of Share Prices without Shorting Them

Abstract

We present a 1-period model of the Polish financial market from the view point of the largest Polish company KGH, whose share prices declined from 119 PLN on June 1, 2015 to 68 PLN on December 2, 2015. Our goal is to show how KGHM might create portfolios (with practically zero cost), which would (almost) fully compensate these declines without, what is very important, short sale of KGHM’s shares. The presented methodology is equally suitable in any country for all those companies for which options on their shares are also tradable. We employ here a matrix model of a fraction of the Polish financial market and make use of the Black–Scholes formula to valuate 3 portfolios replicating 3 desired by KGHM, but not available on the market, financial instruments. To give more insight to the readers, we distinguish two cases. In one of them, volatility of KGHM’s share prices is 33%, and in the other case it equals 20%.