Explanation:
A protective put is a strategy that can protect the portfolio's value. The investor who owns the asset buys a put option on those stocks in exchange for a put premium.
If the stock price increases, the investor will make a gain that will only be reduced slightly by the premium paid. If the stock price decreases, the investor will exercise the option, which will enable them to limit the loss to the strike price of the put.
Option A is incorrect. A long straddle is created by purchasing a call and a put with the same strike price and expiration. It would be suitable if the investor predicts a big price move and/or a great deal of volatility in the near future.
Option C is incorrect. A covered call describes a trading strategy where the seller (writer) of a call option also owns the underlying stock. It would be a good fit if the investor thinks the stock price is unlikely to rise much further in the near future.
Option D is incorrect. A short straddle is created by selling a call and a put with the same strike price and expiration. It would be a good fit when the investor believes the underlying asset will not move significantly higher or lower over the life of the options contract.
Section: Financial Markets and Products
Chapter: Trading Strategies
Learning Objective: Explain the motivation to initiate a covered call or a protective put strategy.
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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.
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