Financial Industry Regulatory Authority (FINRA) Practice Exam 2026 - Free FINRA Practice Questions and Study Guide

The term that describes a strategy where an investor buys an options contract to offset potential losses in an underlying asset is hedging. In this context, hedging refers to taking a position in a financial instrument, such as options, that is designed to reduce the risk of adverse price movements in an asset. By purchasing options, investors can protect themselves against potential declines in the value of their underlying investments, thereby reducing their overall risk exposure.

Hedging is commonly employed to limit losses while still allowing the investor to participate in the potential upside of the underlying asset. For instance, if an investor owns stock and is concerned about a short-term drop in price, they may purchase a put option on the stock. This gives them the right to sell the stock at a predetermined price, effectively setting a floor on their potential losses.

The other choices refer to different financial strategies. Speculating involves taking on risk in hopes of making a profit from price movements, leverage refers to using borrowed funds to increase the potential return on investment, and arbitrage involves exploiting price discrepancies between markets to earn a risk-free profit. Each of these terms represents a separate concept and does not involve the risk management aspect that hedging provides.