Question

A put option gives the holder

A. the obligation to buy an asset at the strike price

B. two of the statements are correct

C. Downside risk protection

D. the right to sell an asset at the strike price

Answer 1

Solution :

A put option is an option which gives the holder the right to sell the asset at a given strike price.

A Put option will be exercised only if, the Spot price of the asset on expiry of the option is lesser than the Strike price of the asset in the put option. Thus a put option holder has a right to exercise the option at his discretion and is not obligated to exercise the option.

The holder of a put option is protected against a fall in the spot price of the asset on the date of expiry of the option. The put option holder is guaranteed the strike price of the option on sale, even when the spot price of the asset falls below the strike price.

Thus the correct solution is option B. Two of the statements are correct.

The two Statements being Statement C. Downside risk protection & D. the right to sell an asset at the strike price

The solution is Option B.

The other options are incorrect due to the following reasons :

A. the obligation to buy an asset at the strike price

A put option gives the seller / writer of the obligation to buy an asset at the strike price. Thus, the put option holder is not under any obligation to buy asset at the strike price. The holder of the put option has the right to sell an asset when the strike price is greater than the spot price on expiry.

Hence, this option is incorrect.

C. Downside risk protection

The holder of a put option is protected against a fall in the spot price of the asset on the date of expiry of the option. The put option holder is guaranteed the strike price of the option on sale, even when the spot price of the asset falls below the strike price.

This statement as a standalone is incorrect. The complete solution is when statements C & D are read together.

D. the right to sell an asset at the strike price

A Put option will be exercised only if, the Spot price of the assets on expiry of the option is lesser than the Strike price of the asset in the put option. Thus a put option holder has a right to exercise the option at his discretion and is not obligated to exercise the option.

This statement as a standalone is incorrect. The complete solution is when statements C & D are read together.