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