5. An investor who has a concentrated position in an energy stock will be best protected with which of the following strategies in a declining market?
Answer: A
Buying puts in the energy stock is the best protection strategy in a declining market.
An investor with a concentrated position in an energy stock can best protect themselves in a declining market by buying puts on that stock. Puts provide the right to sell the stock at a predetermined price, which can help mitigate losses if the stock's price falls.
A) Buying puts in the energy stock
This option is correct because buying put options allows the investor to secure a selling price for their shares, effectively limiting potential losses if the stock price decreases. This strategy provides a direct hedge against the declines in the specific stock, making it a sound choice for someone with a concentrated position.
B) Buying an energy exchange-traded fund (ETF)
Buying an energy ETF is not the best protective strategy as it does not directly hedge the concentrated position in the individual energy stock. While it may diversify exposure to the energy sector, it does not provide the specific downside protection that puts offer, and it could still decline along with the market.
C) Selling a fixed income ETF
Selling a fixed income ETF does not address the risk associated with the specific energy stock position. This strategy would not provide any protection against losses in the concentrated stock, and it might even exacerbate the investor's overall risk profile.
D) Selling calls in the energy stock
Selling calls does not protect against a decline in the stock's price; rather, it generates income by collecting premiums. If the stock price falls, the investor would still be exposed to losses on the underlying stock, making this strategy ineffective for protection.
Conclusion
Buying puts in the energy stock is the most effective strategy for an investor with a concentrated position as it directly mitigates the risk of declines in that specific stock. Other options, such as buying an ETF or selling calls, either do not provide direct protection or could increase exposure to losses. Thus, puts are clearly the best strategy in a declining market for this scenario.