General Securities Representative (Series 7) Practice Exam

What type of options strategy typically involves less risk?

1. Buying naked calls

2. Writing naked puts

3. Buying protective puts

4. Buying straddles

The correct answer is: Buying protective puts

Buying protective puts is an options strategy that is considered to involve less risk because it provides a form of insurance for an investor holding a long position in a stock or other underlying asset. When an investor buys a protective put, they purchase a put option at a strike price that allows them to sell the underlying asset at that price, should the asset's value decline. This limits the potential loss to the difference between the cost of the put option and the strike price, while allowing for unlimited upside potential in the long position. This strategy is particularly useful in volatile markets or during uncertain times, as it helps mitigate the loss on the underlying asset without entirely liquidating the position. The protective put ensures that the investor can protect a portion of their investment from significant downturns while still participating in any upward movements in the asset’s price. Thus, it strikes a balance between risk management and the opportunity for profit, making it a low-risk strategy compared to the others mentioned.