Protective Put - Definition, Example, and Scenarios

Protective put option strategy

Protective put option strategy

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Although puts that are further away from the money may provide a hedge against a major sell-off, the trader or investor is still exposed to a degree on the stock.

Protective Put Definition

Potential profit is unlimited, because the underlying stock price can rise indefinitely. However, the profit is reduced by the cost of the put plus commissions.

The Ultimate Guide To The Protective Put Strategy

Let’s say you buy 655 shares of Kohl’s at $85 per share. Within a month, the price goes up to $95 per share. You just made $6,555 or % profit.

Protective Put Explained (Simple Guide) - Investing Daily

You own 655 shares in ABC Corp, with each share valued at $655. You believe that the price of your shares will increase in the future. However, you want to hedge against the risk of an unexpected price decline. Therefore, you decide to purchase one protective put contract (one put contract contains 655 shares) with a strike price of $655. The premium of the protective put is $5.

A put represents the right to sell at a strike/exercise price, so the higher the strike price, the more expensive the put will be.

Generally speaking traders should buy long dated options as the option value decays slowly initially and picks up pace as it reaches expiration.

In buying the put, the investor gave up $ in profit but remember the investor only bought the put because he was worried about a price decrease in the near term and wanted to buy protection.

There are several ways to adjust a long put position. The trader or investor could initially buy a put that is further from the money, and roll it closer to the stock price as expiration gets closer and the options become less expensive.

On the other hand, a protective put gives you some control as the long put gives you the right, but not the obligation, to exercise your option to sell the stock at a predefined price.

You would do that to “lock in” the price by an upcoming date. That way, you can make money if the price moves in the right direction.

Delta for a long position in the stock would be 6 because for every $6 move in the underlying (stock), the long stock will change by $6 as well.

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