FINRA Series 7Investment Information and Suitable RecommendationsMedium
A client owns 100 shares of ABC stock, purchased at $40 per share. To protect against a potential decline in the stock's price, the client buys 1 ABC Put option with a strike price of $35 for a premium of $3. What is the maximum loss for this protective put strategy?
- A$500
- B$800
- C$3,800
- D$300
Show answer & explanationAnswer & explanation
Correct answer: B. $800
The maximum loss for a protective put is the purchase price of the stock minus the strike price of the put, plus the premium paid for the put. ($40 stock price - $35 put strike) + $3 put premium = $5 + $3 = $8 per share. Multiplied by 100 shares, the maximum loss is $800.
Why the other options are wrong
- A. This is the difference between the stock purchase price and the put strike price, ignoring the premium.
- C. This is the total cost of the stock plus the premium, not the maximum loss.
- D. This would be the loss if the stock price fell to the strike price and the premium was not included.
Protective Put Maximum Loss
The highest potential loss an investor can incur when holding a stock and buying a put option to hedge against a price decline.
- Formula: (Stock Purchase Price - Put Option Strike Price) + Put Premium.
- The put option limits the downside risk of the stock.
- Maximum loss occurs if the stock falls below the put's strike price.
Memory trick: Stock cost minus put floor, then add the put's door fee.