8006 Exam Dumps | Which of the following statements are true: I. Protective puts are a form of insurance against a fall

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Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition
PRMIA.8006.v2021-04-25.q101
Question 34

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Question 34/101

Which of the following statements are true:
I. Protective puts are a form of insurance against a fall in prices
II. The maximum loss for an investor holding a protective put is equal to the decline in the value of the underlying III. The premium paid on the put options held as a protective put is a loss if the value of the underlying goes up IV. Protective puts can be a useful strategy for an investor holding a long position but with a negative short term view of the markets

A. I and IV

B. I, III and IV

C. II and III

D. I, II, III and IV

Correct Answer: B

Explanation
A protective put is a put option purchased to protect against the fall in value of a long position. If the price of the underlying in respect of the long position goes down, the put options helps limit losses. If the price of the underlying goes up, the premium paid on the puts is lost but the investor gets to keep the entire upside from the rise in the price.
Therefore statements I, III and IV are correct. Statement II is not correct as any decline in the value of the underlying is offset by the gain from the put, which is the entire idea behind a protective put.

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