Buying put options in a hedge primarily serves to do what?

Buying put options in a hedge primarily serves to do what?

• A. Increase upside potential.
• B. Limit downside risk.
• C. Guarantee profits.
• D. Eliminate fees.

Answer: (B)

The main concept being tested is using put options for downside protection. When you own or hold a position that could lose value, buying a put acts like insurance: if the asset’s price falls, the put option increases in value or allows you to sell at the strike price, which offsets part or all of the loss on the underlying position. This is how the hedge limits downside risk. It doesn’t increase upside potential because the put costs a premium, and its payoff is most valuable when prices decline. If the market rises, the put may expire worthless, so you don’t gain from the upside beyond what the asset itself provides. It also doesn’t guarantee profits; even with a put, you can lose the premium paid for the option if the price doesn’t move as expected. And while it helps manage risk, it doesn’t eliminate all costs associated with trading, such as the premium and any fees. So the primary purpose of buying put options in a hedge is to limit downside risk.

The main concept being tested is using put options for downside protection. When you own or hold a position that could lose value, buying a put acts like insurance: if the asset’s price falls, the put option increases in value or allows you to sell at the strike price, which offsets part or all of the loss on the underlying position. This is how the hedge limits downside risk.

It doesn’t increase upside potential because the put costs a premium, and its payoff is most valuable when prices decline. If the market rises, the put may expire worthless, so you don’t gain from the upside beyond what the asset itself provides.

It also doesn’t guarantee profits; even with a put, you can lose the premium paid for the option if the price doesn’t move as expected. And while it helps manage risk, it doesn’t eliminate all costs associated with trading, such as the premium and any fees.

So the primary purpose of buying put options in a hedge is to limit downside risk.