FINRA Practice Test Question?

So, I was doing the practice test and I just wanted to confirm that what I am reading would be considered a covered put?


What is the BE formula for that then? Strike+Premium, I’m guessing?

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Hi @StormiSkies,

A covered put (or a covered call) involves selling the option (going short the option and collecting the premium) and then “covering” it by having the matching position to balance out the obligation for the option that you just sold. This question does have a stock leg and an option leg, but the option isn’t sold short and the stock leg doesn’t cover the option, so it is not a covered put.

In this scenario, the customer has bought the stock, along with buying a put, making this “long stock with a long put hedge”. The customer has a bullish outlook for the market but wants protection in case the market falls.

The customer bought the put for $3 to get the ability to sell at $35. If the market rises as intended, the put will expire worthless, so we can forget about the $35 put strike price and just consider the $3 premium. The customer bought the stock in the market at $35, so the price would need to rise by that $3 premium to $35 + $3 = $38 in order for them to offset the cost of the option and break even.

We can also go through what would happen if the market did fall to $32:

  • Bought the option: -$3
  • Bought the stock at original market price: -$35
  • Exercise and sell at option strike price after market falls: $35

So if the market fell to $32, this customer would have lost $300 (3x 100).

In fact, if the market stays at $35 or falls to any price lower, the customer’s loss will still be $300, confirming that this is a hedging strategy.

You can read more about it in our Hedging strategies chapter!

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Ah! Got it: thank you so much for such a thorough explanation, I’ll brush back up on my reading. :smile:

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