Which one of the following statements is correct for an investor who has purchased portfolio insurance by owning a stock and buying a put option on that stock?
A) The investor profits when the stock price declines.
B) Maximum profitability occurs when the stock price equals the exercise price.
C) The value of the position can decline no further than the option's exercise price.
D) The option will certainly be exercised.

Question

Quizplus · Accepted Answer

The correct statement is that the value of the position can decline no further than the option's exercise price. Owning a put option provides downside protection by allowing the holder to sell the stock at the exercise price if the stock price declines. Thus, the investor's maximum loss is limited to the difference between the stock price and the option's exercise price. Option exercise is not certain and dependent on the market conditions at expiration. The maximum profitability occurs when the stock price goes beyond the exercise price. Therefore, option value in the portfolio increases as the underlying security value goes down.

Which One of the Following Statements Is Correct for an Investor