Scribd Logo
Upload

Welcome to Scribd!

  • 7 views

    Protective Put

    Uploaded by

    Unnikrishnan AS

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd

    Protective Put

    Uploaded by

    Unnikrishnan AS
    7 views2 pages

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    7 views2 pages

    Protective Put

    Uploaded by

    Unnikrishnan AS

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    You are on page 1of 2

    Protective Put

    A protective put is an options strategy designed to protect against losses in an


    underlying asset. It involves holding a long position in a stock and purchasing a put
    option on that same stock. This strategy is often used as a form of insurance, providing
    downside protection while allowing for upside potential. Here’s a detailed explanation:

    Components of a Protective Put

    1. Underlying Asset: The investor owns shares of a stock.


    2. Put Option: The investor buys a put option on the same stock. This gives the
    investor the right to sell the stock at a specified price (strike price) within a certain
    period (until the option's expiration date).

    How a Protective Put Works

    ● Stock Ownership: The investor holds shares of a stock that they believe has
    upside potential but wants to protect against possible declines.
    ● Buying the Put Option: The investor purchases a put option with a strike price that
    represents the minimum price at which they are willing to sell the stock. This put
    option acts as insurance against a significant drop in the stock's price.

    Profit and Loss Scenarios

    1. Stock Price Above Strike Price: If the stock price rises above the strike price, the
    put option expires worthless. The investor benefits from the increase in the stock
    price, minus the cost of the put option (the premium paid).
    2. Stock Price Below Strike Price: If the stock price falls below the strike price, the
    investor can exercise the put option and sell the stock at the strike price, limiting
    the loss to the difference between the original purchase price and the strike price,
    plus the premium paid for the put option.
    3. Stock Price at Strike Price: If the stock price is at the strike price at expiration, the
    investor can choose to sell the stock at the strike price, ensuring a sale price that
    limits the loss to the cost of the put option.

    Benefits and Risks

    Benefits

    ● Downside Protection: The put option provides a floor for the stock price, limiting
    potential losses.
    ● Upside Potential: The investor retains the ability to benefit from any increase in
    the stock price, minus the cost of the put option.
    ● Flexibility: The strategy allows the investor to hold onto the stock for its potential
    appreciation while protecting against significant declines.

    Risks

    ● Cost of the Put Option: The premium paid for the put option reduces overall profit.
    If the stock price does not fall, this cost is a realized loss.
    ● Expiration Date: The protection is limited to the duration of the put option. After
    expiration, a new put option must be purchased to continue protection, incurring
    additional costs.

    Example

    Assume an investor owns 100 shares of a stock currently trading at $50 per share. They
    are concerned about potential declines but want to hold the stock for its long-term
    prospects. To protect against a significant drop, they buy a put option with a strike price
    of $45, expiring in three months, for a premium of $2 per share.

    ● Stock Price Rises to $60: The put option expires worthless. The investor's profit is
    ($60 - $50) * 100 - $200 = $800.
    ● Stock Price Falls to $40: The investor exercises the put option and sells the stock
    at $45. The loss on the stock is limited to ($50 - $45) * 100 + $200 = $700.
    ● Stock Price Stays at $50: The put option expires worthless. The investor retains
    the stock and the loss is limited to the cost of the put option, $200.

    In summary, the protective put strategy provides a balance between risk and reward by
    offering downside protection while allowing for participation in potential upside gains.
    This makes it a valuable tool for investors seeking to mitigate risk while maintaining their
    investment positions.

    You might also like