NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client holds 100 shares of XYZ Corp. stock, which they purchased at $50 per share. The current market price of XYZ is $70 per share, and the client is concerned about a potential short-term market downturn eroding their profits. They want to protect their unrealized gains without selling the stock. Which of the following options strategies would be most appropriate?
- ASell a naked put option.
- BSell a covered call option.
- CBuy a naked call option.
- DBuy a protective put option.
Show answer & explanationAnswer & explanation
Correct answer: D. Buy a protective put option.
A protective put strategy involves buying a put option on a stock you own. This gives the investor the right, but not the obligation, to sell the stock at the put's strike price, thereby setting a floor on the potential loss and protecting unrealized gains in a falling market.
Why the other options are wrong
- A. Selling a naked put obligates the client to buy the stock if it falls below the strike price, increasing downside exposure, not protecting against it.
- B. Selling a covered call would obligate the client to sell their shares if the stock rises above the strike price, limiting upside, and does not protect against a downturn.
- C. Buying a naked call is a speculative strategy betting on a rise in stock price and does not protect against a downturn.
Protective Put
An options strategy involving the purchase of a put option on a stock already owned by the investor. It acts as an insurance policy, setting a floor on potential losses while allowing the investor to benefit from any upside appreciation of the stock.
- Investor owns the underlying stock.
- Buys a put option.
- Protects against a decline in stock price.
- Sets a floor on potential losses.
Memory trick: To 'Protect' your stock, 'Put' on some insurance.