Forward sell ko replicate

Imagine you want to make a deal to sell 1,000 shares of a stock in three months. To do this, you can follow a strategy.

First, at the beginning (t=0), you “short sell” those 1,000 shares. It means you borrow them and sell them with the hope that their price will go down. Now, you’ve got some money from this sale.

Next step, you take that money and invest it in something safe, like a savings account with an interest rate (we call it the risk-free rate).

After three months (t=T), you buy back the 1,000 shares to return them to the lender. Hopefully, the stock price has dropped, and you can buy them back for less money than what you got when you initially sold them.

Now, here’s the clever part. The money you make from this process is like a fixed return. The idea is to make sure that this return is equal to what you would get if you directly entered into a forward contract to sell the shares.

In simple terms, you’re creating a secure way to make money by selling stocks, investing the proceeds, and then buying back the stocks later. The use of the risk-free rate ensures a safe and predictable process. This strategy helps you avoid the ups and downs of the stock market and still make a reliable profit.