FINRA Series 7Investment Information and Suitable RecommendationsHard
An investor purchases 100 shares of ABC stock at $80 per share. Simultaneously, they purchase 1 ABC 75 Put for a premium of $4. At what stock price will the investor break even on this protective put strategy?
- A$76
- B$84
- C$79
- D$75
Show answer & explanationAnswer & explanation
Correct answer: B. $84
The breakeven point for a protective put strategy is the stock purchase price plus the premium paid for the put. In this case, $80 (stock purchase price) + $4 (put premium) = $84. At this price, the investor would recover their initial investment in the stock and the cost of the put option.
Why the other options are wrong
- A. This is an incorrect calculation and does not represent the breakeven point.
- C. This is an incorrect calculation; it might be mistaken for the breakeven point of a covered call.
- D. This is the strike price of the put, which is the floor of protection, not the breakeven.
Protective Put Breakeven
The breakeven point for a protective put strategy (long stock + long put) is the price at which the investor recovers their total outlay, which includes the stock purchase price and the premium paid for the put option.
- Strategy: Long Stock + Long Put.
- Breakeven Formula: Stock Purchase Price + Put Premium.
- Represents the point where total costs are recovered.
- Below breakeven, the investor starts to lose money until the put's strike price.
Memory trick: Stock cost plus put cost equals breakeven.