FINRA Series 7Investment Information and Suitable RecommendationsMedium
An investor owns 100 shares of ABC stock, currently trading at $50 per share. To protect against a potential decline in the stock's value while allowing for some upside potential, the investor buys 1 ABC Oct 45 Put for $2. What is the maximum loss this investor faces?
- A$500
- B$200
- C$700
- D$4,700
Show answer & explanationAnswer & explanation
Correct answer: C. $700
This is a protective put strategy. The maximum loss occurs if the stock price falls to zero. The loss is limited to the difference between the stock purchase price and the put option's strike price, plus the premium paid for the put.
Why the other options are wrong
- A. This is the difference between the stock price and the put strike, missing the premium.
- B. This is the premium paid for the put, not the maximum loss.
- D. This is the put strike price minus the premium, which is not the maximum loss.
Protective Put Maximum Loss
The highest potential loss for an investor using a protective put strategy, which is limited to the difference between the stock's purchase price and the put's strike price, plus the premium paid for the put.
- Strategy involves owning stock and buying a put option on that stock.
- Used to hedge against downward price movements.
- Maximum loss occurs if the stock falls to zero.
Memory trick: Protective Put: Protects your portfolio, Puts a floor on losses.