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Protective Put

The protective put, or put hedge, is a hedging strategy where the holder of a security buys a put to guard against a drop in the stock price of that security. 

Protective Put Construction
Long 100 Underlying
Buy 1 ATM Put

A protective put strategy is usually employed when the options trader is still bullish on a stock he already owns but wary of uncertainties in the near term. It is used as a means to protect unrealized gains on shares from a previous purchase.

Unlimited Profit Potential

There is no limit to the maximum profit attainable using this strategy. The protective put is also known as a synthetic long call as its risk/reward profile is the same that of a long call's.

The formula for calculating profit is given below:

  • Maximum Profit = Unlimited
  • Profit Achieved When Price of Underlying > Purchase Price of Underlying + Premium Paid
  • Profit = Price of Underlying - Purchase Price of Underlying - Premium Paid
Profit Graph for the Protective Put Options Trading Strategy

Limited Risk

Maximum loss for this strategy is limited and is equal to the premium paid for buying the put option.

The formula for calculating maximum loss is given below:

  • Max Loss = Premium Paid + Commissions Paid
  • Max Loss Occurs When Price of Underlying <= Strike Price of Long Put

Breakeven Point(s)

The underlier price at which break-even is achieved for the protective put can be calculated using the following formula.

  • Breakeven Point = Purchase Price of Underlying + Premium Paid

Example

An options trader owns 100 shares of XYZ stock trading at $52 in June. He implements a protective put strategy by purchasing a SEP 50 put option trading at $200 to insure his holdings.

Maximum loss occurs when the stock price dive to $50 or below at expiration. With the SEP 50 put in place, even if the stock price dive to $30, he will still be able to sell his holdings for $5000. Therefore, his maximum loss is limited to $200 in paper loss + $200 in premium paid for the put option which comes to $400.

On the upside, there is no limit to the profits should the stock price head north. Suppose the stock price goes up to $70, his profit will be $1800 in paper gain less $200 paid for the put protection for a total of $1600.

However, if the stock price remain unchanged at expiration, he will still lose $200 in premium paid for the put insurance.