Covered Put Strategy: Cash Cushions and Downside Liability
An investor who is short 100 shares of stock at $50 simultaneously sells 1 Oct 50 Put at $4.00. What is the investor's maximum potential profit and maximum potential loss on this covered put position?
A covered put (short stock + short put) has maximum profit capped at the premium ($400) and UNLIMITED loss if the stock surges upward.
Complete Analysis & Legal Rationale
Because the investor is short the underlying stock, an upward surge exposes the investor to unlimited losses despite collecting the $4.00 put premium. The maximum profit occurs if the stock falls to $50 or below, forcing the put to be exercised, buying back the short stock at $50 and leaving the $4.00 ($400) premium profit.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
A covered put (short stock + short put) has maximum profit capped at the premium ($400) and UNLIMITED loss if the stock surges upward.
Fails to reflect correct options pricing/mechanics for B.
Fails to reflect correct options pricing/mechanics for C.
Fails to reflect correct options pricing/mechanics for D.
Official Standard: Because the investor is short the underlying stock, an upward surge exposes the investor to unlimited losses despite collecting the $4.00 put premium.