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What is Protective Put?

Options contracts are a good way for short-term gains using the price movements of a stock. That being said, they are riskier than regular equity investments. There are several strategies in these trading instruments, and protective put is one of them.

What is a Protective Put?

The protective put strategy or the married put is an options strategy that contains buying or owning the stock and, after that, buying one put at a strike price. The investor that enters this strategy wishes for the stock to trade higher but also needs protection in the case of the stock price falling below the strike price. This gives the investor the right to sell the stock.

A protective call option is typically when the investor is nervous about the market and needs downside protection while letting themselves also make profits on the upside. The protective put behaves as the price floor that limits the amount an investor could lose if the stock continues to trade lower. Once the stock has moved under the strike price of the protective put, the investor is protected from enduring more losses.

How does the Protective Put Work?

If an investor is already long a stock, he or she runs the risk of losing money if the stock falls in value. However - by purchasing a protective put option, an investor ensures that if the stock continues to fall, he or she will be able to sell it at a certain price, limiting their losses.

Since the investor has a contract in place to sell a stock at a specific price if they so choose, they are establishing a price floor that protects their asset.

The protective put functions as asset insurance, and it comes with a premium, just like any other sort of insurance. The premium is determined by the investor's desire to establish a price floor as well as volatility, which represents the likelihood of the stock's price sliding further lower. The length of time the insurance lasts is also limited; the longer the investor wants his insurance to last, the higher the protective put buy price will be.

When to Use the Protective Put Strategy?

As the stock market may be rather unexpected at times, you may wish to protect yourself against potential price declines in the stock you are positive on. This is when planning comes into play. Only utilize the protective put approach if you have a long position in a stock.

Premiums of Protective Put

An investor has various options when executing a protective put, including the level strike price to choose and the expiration date. Typically, investors opt for a put option that is out of the money. When the strike price is lower than the current stock price, this is known as a bearish situation. The price distinction between the current stock price and the level where the protective put provides insurance does not give total protection. However, the cost of this protective put is lower.

Investors who are more concerned about stock price declines may opt to buy at the money put. This more aggressive defensive put provides 100% protection against potential losses, but it comes at a higher cost. Premiums for long-term protective puts are likewise higher.

Advantages of the Protective Put Strategy

  • Protective puts set a minimum price at which you can sell your shares, reducing the amount of money you can lose by owning a stock.
  • As you're not compelled to exercise a put, it won't affect your potential gains if the stock price climbs dramatically.
  • The maximum profit is limitless because owning the stock permits the investor to profit as the stock rises in value.

The maximum loss is computed by adding the cost of the long put to the distinction between the stock price and the long put.

What is Protective Put? - FAQs

What is an example of a protective put?

A protective put is created by buying stock and buying put options on a share for share basis.

Is a protective put a good option?

If you are an investor who is inclined to protect your investment with puts, you need to make sure that the cost of the put is worth the protection given.

What is the cover called and the protective put?

Call and put options are used to manage risk for the holders of the underlying risk.

Is the protective put equal to a long call?

A protective put strategy is also popularly known as a synthetic long call or married put; it is an options strategy that contains buying or owning the stock and then buying one put at the strike price.

Is married put and protective put the same?

The married put and the protective put strategy are identical, except for the time when the stock has been acquired.

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