NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client owns 100 shares of ABC Corp. stock, currently trading at $75 per share. They are concerned about a potential short-term market downturn but do not want to sell their shares. They wish to protect against a significant loss in value while still participating in some upside. Which option strategy would best meet their objective?
- ABuy a call option.
- BBuy a protective put.
- CSell a covered call.
- DSell a naked put.
Show answer & explanationAnswer & explanation
Correct answer: B. Buy a protective put.
Buying a protective put option gives the client the right, but not the obligation, to sell their shares at a predetermined price (the strike price) if the market falls, thereby limiting their downside risk while allowing them to benefit from any share price appreciation.
Why the other options are wrong
- A. Buying a call option is a bullish strategy that provides no downside protection for existing shares.
- C. Selling a covered call limits upside potential and offers limited downside protection (only the premium received).
- D. Selling a naked put involves significant risk if the stock price falls, as it obligates the seller to buy shares at the strike price.
Protective Put
An options strategy where an investor buys a put option on a stock they already own to protect against a decline in the stock's price.
- Provides a floor for potential losses.
- Allows participation in potential upside gains.
- Cost is the premium paid for the put option.
Memory trick: Options: Right to buy or sell, for protection or speculation.