Protective Put

B is correct. Purchasing protective puts is the most appropriate strategy for Maria's situation. The puts provide downside protection by establishing a price floor near the current $95 level, limiting potential losses while maintaining unlimited upside potential if ABC continues to rise. This strategy allows her to defer capital gains taxes while protecting her unrealized gains during the volatile period she anticipates.

A (covered calls) provides only limited downside protection equal to the premium received, not full protection. While covered calls generate income, they also cap upside potential at the strike price, which conflicts with Maria's goal of maintaining upside participation. C (selling the stock) would trigger the capital gains taxes she wants to avoid and eliminates all upside potential. D (selling naked puts) creates additional downside risk rather than protection, requiring her to buy more shares if the stock falls, which is completely inappropriate for someone seeking protection.

B is correct. A protective put consists of owning the underlying stock (long stock position) and purchasing put options on the same stock (long put position). This combination provides downside protection because the put gives the right to sell the stock at the strike price, establishing a price floor.

A incorrectly describes selling puts instead of buying puts. Selling puts creates obligation and additional downside risk, not protection. C describes a short stock position hedged with long calls, which is a different strategy used to protect short positions, not long positions. D describes a covered call strategy (long stock + short call), which generates income but provides only limited downside protection and caps upside potential.

C is correct. Calculate maximum loss using the formula: Maximum Loss = (Stock Purchase Price - Put Strike Price) + Premium Paid = ($60 - $50) + $4 = $14 per share. This represents the worst-case scenario where the stock falls to zero or well below the $50 strike price, and the investor exercises the put to sell at $50, resulting in a $10 loss on the stock position ($60 purchase - $50 sale) plus the $4 premium paid for the put.

A ($4) incorrectly assumes the maximum loss is only the premium paid, ignoring the potential stock loss from purchase price down to the strike price. B ($10) represents only the stock loss from purchase price to strike price ($60 - $50), but fails to include the $4 premium cost. D ($15) might result from incorrectly adding the current price decline potential ($75 - $60 = $15), but maximum loss is calculated from the original purchase price to the protected strike price, plus premium.

C is correct (the EXCEPT answer). This statement is FALSE. Protective puts do NOT eliminate all risk or guarantee no loss. While the put establishes a price floor (the strike price), the investor can still lose money if the stock declines from the purchase price to the strike price, plus the cost of the premium. For example, stock purchased at $60, protected with a $50 put for $4 premium: maximum loss is $14 per share, not zero.

A is accurate: protective puts provide downside protection below the strike price while maintaining unlimited upside potential if the stock rises (unlike covered calls which cap upside). B is accurate: the premium paid for the put is a cost that reduces overall returns, similar to paying for insurance. D is accurate: protective puts are ideal for investors who want to hedge against downside risk without selling their stock and potentially triggering taxes or missing future upside.

D is correct. All four statements are accurate.

Statement 1 is TRUE: The put with a $110 strike gives the investor the right to sell at $110, providing protection against any decline below that level. If the stock falls to $90, the investor can exercise and sell at $110, limiting the downside.

Statement 2 is TRUE: Protective puts do not cap upside potential. If the stock rises to $150, the investor participates fully in the gain (the put simply expires worthless, costing only the premium).

Statement 3 is TRUE: The premium paid for the put increases the total cost basis of the position. If the original purchase was at $80 and the investor pays a $5 premium for the put, the effective cost basis becomes $85, raising the breakeven point from $80 to $85.

Statement 4 is TRUE: Covered calls cap upside potential at the call strike price, while protective puts maintain unlimited upside. If maintaining upside potential is a priority (while still getting downside protection), protective puts are more suitable than covered calls, though they cost premium rather than generating premium income.