General Securities Representative (Series 7) Practice Exam

What defines a covered put position for an investor?

1. Having a long position in the underlying stock

2. Owning a put with a lower strike price

3. Having a short position on the stock

4. Holding a bank escrow agreement

The correct answer is: Having a short position on the stock

A covered put position is defined by an investor having a short position on the underlying stock. This strategy involves selling a put option while simultaneously holding an equivalent short position in the stock. If the price of the stock falls below the strike price of the put option, the investor may be obligated to purchase the shares at the strike price, but since the investor is already short the stock, they can deliver the shares they have sold short. This creates a situation where the risk is covered because the investor already has shares they would need to deliver. In addition, the other choices do not correctly define a covered put position. A long position in the stock refers to ownership of shares, which is not relevant to a covered put. Owning a put with a lower strike price does not provide coverage for the risk of being short the stock. Lastly, holding a bank escrow agreement is unrelated to options trading and has no bearing on covered put positions. Therefore, the correct characterization of a covered put involves the investor holding a short position on the stock.