FACTS ABOUT PROTECTIVE PUT is a poplar option trading strategy amongst stock traders. It is a put option purchased by an investor for an underlying security that is already owned by the holder of the option and investors would use Protective Put whenever their stocks have risen to the point where its profit already needs protection. Protective Put defends against a drop in underlying stock price. Generally, investors employing Protective Put strategy has unrealized profits accrued from an increase in value of the shares. They might have concerns about unknown, downside market risks and is worried of uncertainties in the near term.
Protective Put protects unrealized profits of stocks so that no shares need to be sold to lock in the profits so far. Though stock traders can protect unrealized profits on shares by liquidating a part of holding, this process denies the trader access to future profit should the stock continues to do well. And this dilemma was solved by using Protective Put. Once the Protective Put is in place, the put option will appreciate in step with any depreciation in the stock price, hedging against any complete losses. This strategy which is also referred to as a “married put,” “puts and stock” or “bullets,” is an ideal strategy for an investor aiming for a full hedging coverage for their position.
Another major benefit of employing in Protective Put is that the investor retains all benefits of continuing stock ownership during the life of the put contract, unless the investor sells his stock. Protective Put also serves to limit downside losses in unrealized gains accrued since the purchase of the underlying stock. And when the value of the underlying stock decreases during the option’s lifetime, Protective Put guarantees the investor the right to sell his shares at the put’s strike price until the expiration of the option. If there is a sudden significant decrease in the market price of the underlying stock, the Protective Put investor has the luxury of time to react.
Protective Put has been proven to be a very beneficial option trading strategy. Aside from allowing the owner to hold on to his stocks while ensuring against the losses Protective Put also allows the investor to transform quickly into a synthetic straddle in order to profit both from up and down moves. It is also used as a means to protect unrealized gains on shares from previous purchase. Maximum loss for this strategy is also limited and is equal to the premium paid for purchasing the put option. On the other hand, one minor disadvantage of Protective Put is the fact that the cost of the put option eats into profit margin. In spite of this disadvantage, it is obvious that the benefits that a Protective Put investor enjoys outweigh the option’s disadvantages.
As a reminder and clarification, put gives the owner the right not an obligation to sell a certain stock at a specific price at a specified date. With this opportunity, the buyer pays a premium and the seller who receives the premium needs to take delivery of the stock should the buyer wants to sell the stock at the strike price by the specified dated. A put when used strategically offers maximum protection against substantial loss.
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