What might prompt a trader to create a protective put?

What might prompt a trader to create a protective put?

• A. To maximize potential gains with high risk
• B. To insure an existing long position against potential loss
• C. To speculate on sudden price increases
• D. To enhance daily cash flow from assets

Answer: (B)

Creating a protective put is a strategy typically employed by traders to safeguard an existing long position against potential losses. When a trader holds a long position in a stock or asset, they are exposed to the risk of a decline in the asset's price. By purchasing a put option for that asset, the trader secures the right to sell the asset at a predetermined price within a specific timeframe. This means that if the asset's price falls below the strike price of the put option, the trader can exercise the option and minimize their losses. This strategy effectively acts as an insurance policy for the long position, allowing the trader to protect their investment while still benefiting from potential upside movement. Such a strategy is particularly useful in uncertain market conditions where the trader wishes to retain their position but also wants to mitigate potential risks.

Creating a protective put is a strategy typically employed by traders to safeguard an existing long position against potential losses. When a trader holds a long position in a stock or asset, they are exposed to the risk of a decline in the asset's price. By purchasing a put option for that asset, the trader secures the right to sell the asset at a predetermined price within a specific timeframe. This means that if the asset's price falls below the strike price of the put option, the trader can exercise the option and minimize their losses.

This strategy effectively acts as an insurance policy for the long position, allowing the trader to protect their investment while still benefiting from potential upside movement. Such a strategy is particularly useful in uncertain market conditions where the trader wishes to retain their position but also wants to mitigate potential risks.