CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
An investor holds a stock that has risen sharply and wants protection against a price fall below a floor while keeping the ability to benefit from further gains. Which strategy is the most appropriate?
Buying a put option is most appropriate. The protective put sets a minimum value for the position, at the strike minus the premium paid, while leaving the investor free to benefit from further price gains. A forward sale would remove the upside, and a covered call caps it.
- ASell a forward contract on the stock
- BBuy a put option on the stockCorrect
- CWrite a covered call on the stock
Explanation
A protective put sets a floor on losses at the strike less the premium while keeping upside. A forward sale locks in a price and removes upside. A covered call gives only limited downside protection and caps gains.
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