Question

With a protective put strategy, an advantage of selecting a low strike price for the put option is:

A. it provides stronger protection than a put with a higher strike price

B. it costs less to buy than a put option with a higher strike price

C. the cash inflow from the premium is higher than for a put option with a higher strike price

D. the maximum loss is smaller than for a put option with a higher strike price

Answer 1

Answer: Option "B". It costs less to buy than a put option with a higher strike price.

Lower strike Put means Out of the money (OTM) Put. Out of the money options are cheaper than At the money and In the money options.

Protective Put strategy- This is an option strategy, when you own a company's shares and you think the price may come down in short term of that stock then to minimize the risk and hedge your position, You buy an OTM Put option.

Put- It is a right but not the obligation to sell an underlying, It is bought when trader/investor is bearish towards a particular stock, it gives profit when stock comes down.

In this strategy, An Out of-the-money (Lower strike) Put is bought, premium is paid upfront.

Maximum profit- Unlimited

Maximum loss- Limited to the extent of premium paid to buy Put option.

For example: If You own 100 shares of ABC Inc., It is trading at $95. You expect that price may come down in short term but may go up in long term then you want to minimize the loss of your portfolio value then you buy Put option of 90 @ $5, when the ABC Inc.'s stock price comes down, your Put will go up and you will get profit, If it goes up, Your loss will be limited to premium paid.