FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client owns 100 shares of ABC stock, currently trading at $70 per share. To protect against a potential decline in the stock price, the client buys 1 ABC 65 Put for a premium of $4. What is the breakeven point for this protective put strategy?
- A$74
- B$61
- C$69
- D$65
Show answer & explanationAnswer & explanation
Correct answer: A. $74
The breakeven point for a protective put is the stock purchase price plus the premium paid for the put option. This is the point where the investor neither gains nor loses money.
Why the other options are wrong
- B. This is incorrect. It would be the strike price minus the premium.
- C. This is incorrect. It subtracts the premium from the stock price, which would be the breakeven for a covered call.
- D. This is the strike price of the put, not the breakeven point.
Protective Put Breakeven
The breakeven point for a protective put strategy (long stock, long put) is the original stock purchase price plus the premium paid for the put option.
- Protective puts are used to limit downside risk on a long stock position.
- The cost of the put increases the breakeven point.
- Maximum loss is limited to the stock purchase price minus the strike price plus the premium.
Memory trick: A protective put is like buying insurance for your stock; the premium raises your 'no-loss' point.