- CFA Exams
- CFA Level I Exam
- Study Session 16. Derivatives
- Reading 49. Basics of Derivative Pricing and Valuation
- Subject 7. The Value of a European Option at Expiration

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**CFA Practice Question**

A trader has purchased a put with an exercise price of $45 and has also bought the underlying stock when its price was $50 a share. Which of the following statements is CORRECT?

A. If the stock price falls, the trader will lose the premium paid on the option.

B. If the stock price falls, the trader's maximum loss will equal $5 per share plus the premium paid.

C. If the stock price rises, the trader will lose the premium paid and $5 per share.

**Explanation:**A put is exercised when the price of the underlying falls. In this case, the trader will exercise the put if the stock price were to fall below $45. The gain upon exercise will offset the loss on the stock. However, the put will not be exercised until the stock price reaches 45. Thus, the first part of the loss equal to $5 (=50 - 45) will be borne by the trader. He also loses the premium paid for the option upon exercise.

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**User Contributed Comments**
2

User |
Comment |
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Shelton |
Protective put: buy S, long Put proceed=(S_T-S_0)+max(X-S_T,0)-Premium => max loss=(0-50)+45-Premium |

ksnider |
this one was tricky |