To answer this question, we need to understand the memory addressing capabilities of the 8086 processor.
The 8086 processor is a 16-bit processor, which means it can address a maximum of 2^16 (or 64KB) memory locations directly. However, the 8086 processor supports a memory segmentation mechanism that allows it to access more memory.
In the case of the 8086 processor, the memory is divided into segments of 64KB each. These segments can overlap, allowing the processor to address a total of 2^20 (or 1MB) memory locations.
Therefore, the correct answer is option C) 1MB. This option is correct because the 8086 processor can address a maximum of 1MB of memory using its memory segmentation mechanism.