FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client owns 100 shares of XYZ stock, purchased at $40 per share. The stock is currently trading at $60. The client believes the stock might decline temporarily but wants to hold onto the shares long-term. Which of the following options strategies would BEST suit this client's objective?
- ASell 1 XYZ 50 Put
- BBuy 1 XYZ 65 Call
- CBuy 1 XYZ 55 Put
- DSell 1 XYZ 60 Call
Show answer & explanationAnswer & explanation
Correct answer: C. Buy 1 XYZ 55 Put
The client wants to protect against a potential decline while retaining the long-term holding. Buying a put option (a protective put) provides the right to sell the stock at a specified price, thus limiting downside risk, while still allowing for unlimited upside if the stock price continues to rise after the temporary decline.
Why the other options are wrong
- A. Selling a put would obligate the client to buy more shares at $50 if the price drops below $50, increasing risk, not protecting.
- B. Buying a call would be a bullish strategy, betting on the stock to rise, and does not protect the existing shares from a decline.
- D. Selling a call would obligate the client to sell the stock at $60, limiting upside potential if the stock rises significantly.
Protective Put Strategy
An options strategy involving owning the underlying stock and simultaneously buying a put option on that stock to protect against a decline in its price.
- Used to hedge an existing long stock position.
- Provides downside protection (a 'floor') for the stock.
- Allows for unlimited upside potential if the stock increases in value.
- Cost is the premium paid for the put.
Memory trick: Puts Protect Portfolios: Buying puts puts a floor on losses.