Explanation
A protective put strategy is a risk management strategy that involves:
- Long position in the underlying asset - This means you own the asset (stock, index, etc.)
- Long put option on the same asset - This gives you the right to sell the asset at a predetermined price (strike price)
Why this is correct:
- The protective put strategy is designed to protect against downside risk while maintaining upside potential
- The long put option acts as insurance - if the asset price falls below the strike price, you can exercise the put and sell at the higher strike price
- You still participate in any upside movement of the asset
Why other options are incorrect:
- Option A: This describes a synthetic long call position (long put + long bond), not a protective put
- Option C: This describes a covered call or protective call strategy, not a protective put
Key characteristics of protective put:
- Maximum loss: Limited to (Purchase price of asset - Strike price of put + Premium paid for put)
- Maximum gain: Unlimited (asset can appreciate without limit)
- Breakeven point: Purchase price of asset + Premium paid for put
- Cost: Premium paid for the put option (this is the cost of insurance)
This strategy is commonly used by investors who want to protect existing long positions from significant downside risk while maintaining exposure to potential upside.
