If you’re planning to trade options, chances are you’ve come across numerous buying and selling strategies. Cash-secured puts, covered calls, long puts, and more. But one buying strategy that stands out is a protective put.
Keep reading to know what protective puts are, how they work, and what makes them beneficial:
What is a Protective Put?
A protective put is an options strategy that involves buying (or owning) a stock and then buying a put option on that given stock. This will give you the right to sell the stock at a specific price (called the strike price) before the option expires at the expiration date.
To reiterate, it means buying a put on an investment you already own or that you buy at the same time you buy a put. So you buy the put as well as the underlying shares simultaneously. This is why the strategy is often called a married put.
So, who uses the protective put strategy?
We have those investors who are bullish on the long-term prospects of an investment, such as a stock or an ETF. These investors want to limit their risk in the short-term market.
By owning the stock, investors position themselves to benefit from any potential profits that may arise from price fluctuations. So the added put works as an insurance policy against big losses.
How Does It Work?
Take a look at these steps to better understand protective puts.
- Buying the stock. An investor first buys shares of a stock.
- Buying the put. The investors simultaneously or later purchase a put option on that same stock.
- Risk limitation.
Let’s look at an example: Imagine buying 100 shares of a company for $100 each. You buy one put option with a strike price of $90 and pay $5 premium for each company share.
If the stock price rises, let’s say to $110, your maximum profit on the shares you own will also increase. The put option will expire at a given date, but you still benefit from the stock’s gain. However, if the stock price falls, you can still benefit from the put.
Even if the stock drops to $80, you will still have the option to exercise your put option and sell at $90. This will limit your loss per share. This is why a protective put is known for protecting your portfolio against losses.
Benefits of Using Protective Puts
Some benefits of protective puts include:
- Market volatility management
- Strategic planning
- Better portfolio diversification
- Flexible risk management
Before you buy a put, be aware that the strategy entails certain costs and risks.
For instance, you need to pay a premium when buying a put. This is the maximum loss you will incur if the stock price rises above the strike price.
Another risk is the fast-approaching expiration date. The contract only lasts until the option’s expiration date. Once that’s hit, you lose insurance and are left unprotected against future losses.
For more information, check out SoFi’s options trading platform.
