General Securities Representative (Series 7) Practice Exam

How is the premium received by the writer of a put option accounted for if the put is assigned?

1. Added to the cost basis

2. Subtracted from the cost basis

3. Considered taxable income

4. Treated as a capital gain

The correct answer is: Subtracted from the cost basis

When a put option is assigned, the premium received by the writer of the put option is subtracted from the cost basis of the stock that is purchased upon assignment. This means that if the put option is exercised, the writer is obligated to buy the underlying stock at the strike price. The effective cost basis of that stock is adjusted downward to reflect the premium received for writing the put option. For example, if a put option has a strike price of $50 and the writer received a premium of $5 for the option, upon assignment, the writer would purchase the stock for $50; however, the adjusted cost basis would actually be $45 ($50 strike price minus the $5 premium). This means that any future profit or loss on the sale of the stock will be calculated from this reduced basis. This accounting treatment helps to clear up the actual economic impact of the transaction, allowing for a more accurate reflection of gains or losses when the stock is eventually sold. The other options do not correctly reflect how the premium is treated in accounting terms post-assignment.