NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Derivatives
A PMS manager holds a stock portfolio worth Rs 1 crore and buys a protective Nifty put option position. Compared with an unhedged portfolio, what is the main trade-off of this strategy?
The trade-off is that a protective put limits downside losses but costs a premium. If markets do not fall, that premium is lost and reduces portfolio returns, while the upside on the stocks remains available, less the premium paid.
- ADownside is limited, but the premium paid reduces returns if markets do not fallCorrect
- BUnlimited upside is lost because the put caps gains
- CThe investor must pay daily mark-to-market on the put
- DThe strategy removes all market risk and premium cost
Explanation
A long put gains when the index falls, limiting losses, while upside remains open. The cost is the premium, which is lost if markets rise or stay flat. Buyers of options do not pay daily mark-to-market margin, and the put does not cap gains.
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