Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksHard
A client holds a significant position in a technology stock and is concerned about a potential short-term decline in its price. To protect against this downside risk without selling the stock, the client could implement which of the following option strategies?
- ABuy a put option
- BSell a put option
- CSell a call option
- DBuy a call option
Show answer & explanationAnswer & explanation
Correct answer: A. Buy a put option
Buying a put option gives the holder the right to sell the underlying stock at a specified strike price. This strategy acts as an insurance policy, protecting against a decline in the stock's market price below the strike price, as the put's value increases when the stock price falls.
Why the other options are wrong
- B. Selling a put option obligates the seller to buy the stock if it falls, exposing them to downside risk, not protection.
- C. Selling a call option limits upside potential and provides limited premium income, but does not protect against a decline in the stock's price.
- D. Buying a call option profits from a price increase, not protection against a decline.
Protective Put
An option strategy where an investor buys a put option on a stock they already own to protect against a decline in the stock's price.
- Provides downside protection for a long stock position
- Limits potential loss to the strike price of the put minus premium paid
- Allows for unlimited upside potential on the stock
- Cost is the premium paid for the put option
Memory trick: Put Protection: Buy a PUT to protect your stock from a DOWNfall.