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Explanation:
The investment manager already has a long position in Black Cola Inc.'s equity. He wants a strategy that allows him to participate in the upside gain of the stock while strictly limiting his downside losses in case the stock drops. A Protective Put strategy involves owning the underlying asset and buying a put option on that asset. If the stock price increases, his stock portfolio gains value (minus the put option premium paid). If the stock price decreases, the put option gains value, effectively capping the maximum loss at the strike price level. Hence, a protective put directly serves his purpose, making option B the correct answer.
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Q.22 Adam Ponting, an Australian investment manager at Sydney Grand Investments, is managing a portfolio of equities of American blue-chip companies. The largest portion of the portfolio is a 35% exposure to Black Cola Inc. Black Cola has recently faced significant operational and managerial changes. This situation has made it difficult to estimate the direction of the stock price. Ponting intends to use options to construct a position that would help him gain if the stock price increases and limit losses if the price decreases – without creating too much risk. Which of the following strategy will serve this purpose?
A
Long straddle.
B
Protective put.
C
Covered call.
D
Short straddle.