FRM Part I · FRM Exam Part I · Trading Strategies
Which statement best describes the payoff profile of a protective put (long stock plus long put) compared with a covered call (long stock plus short call)?
The protective put gives a floor on losses with unlimited upside, net of the premium. The covered call caps upside at the strike and only cushions downside by the premium received, so large declines still produce substantial losses.
- ABoth strategies cap upside and limit downside
- BThe protective put has limited downside and unlimited upside, while the covered call has capped upside and substantial downsideCorrect
- CThe protective put has capped upside and substantial downside, while the covered call has limited downside
- DBoth strategies have unlimited upside and a floor on losses
Explanation
The long put sets a floor on losses while leaving gains uncapped, net of the premium. The short call caps gains at the strike and gives only a small premium cushion against falls. The other options reverse or blend these features.
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