FINRA Series 7Investment Information and Suitable RecommendationsHard
A client owns 100 shares of XYZ stock, purchased at $70 per share. To protect against a potential decline in the stock's price, the client buys 1 XYZ Put 65 for a premium of $3. What is the maximum potential loss for this protective put strategy?
- A$800
- B$300
- C$6,500
- D$500
Show answer & explanationAnswer & explanation
Correct answer: A. $800
The maximum loss for a protective put strategy occurs if the stock falls below the put's strike price. The loss is limited to the difference between the stock's purchase price and the put's strike price, plus the premium paid for the put. ($70 - $65) + $3 = $5 + $3 = $8 per share. For 100 shares, the maximum loss is $8 * 100 = $800.
Why the other options are wrong
- B. This is the put premium, not the total maximum loss.
- C. This represents the value of the stock at the strike price, not the maximum loss.
- D. This is the difference between the stock purchase price and the strike price ($70 - $65 = $5), but it doesn't include the premium.
Protective Put Maximum Loss
The maximum loss for a protective put strategy is limited to the difference between the stock's original purchase price and the put option's strike price, plus the premium paid for the put. This occurs if the stock declines below the put's strike price.
- Strategy involves owning stock and buying a put option.
- Loss is capped at a specific value.
- Occurs when stock price falls below the put's strike.
Memory trick: Stock Cost Minus Strike, Plus Put Premium equals Max Pain.