Fundamentals
Protective Put
A protective put is similar to a long put, but the investor also owns the underlying equity. In these scenarios, investors are typically looking to protect against a significant stock price decline, and limit their potential losses.
- Outlook: Bearish
- Use: If you want to hedge your investment against a fall in the stock price
Basic example
Let’s take the same example as the long put. You own 100 shares of FlyFit, currently trading at $70 per share. You anticipate there’s a chance the stock price declines in the coming months. You’re not quite ready to sell the investment, but want to hedge your risk.
- Strike price: $65Price you want to limit your losses to. Strike price represents the price you’d receive if you were to exercise your put
- Contract price: $3Per-share price of the option contract
- Total cost: $300Options have a contract multiplier, or the number of shares presented. Total cost is the contract price x the contract multiplier, or $3 x 100 for this FlyFit option
If you exercise your put option, you’d sell your 100 shares of FlyFit for a total cost of $6,500.
Hedging your losses
Since you own 100 shares of FlyFit, if you sold your shares in the market, you’d generate proceeds of $5,000, capturing a loss of $1,500 from the $70 peak a few days ago.
However, you have a put option with a strike price of $65, so instead, you sell your 100 shares for $65 each, or $6,500 total. You’ve capped your losses on the positions at $500. But remember that you initially paid $300 for the put, so we need to subtract that premium, capping your net losses at $800.
However, you have a put option with a strike price of $65, so instead, you sell your 100 shares for $65 each, or $6,500 total. You’ve capped your losses on the positions at $500. But remember that you initially paid $300 for the put, so we need to subtract that premium, capping your net losses at $800.
Stock price rises
Let’s say you’re wrong, and FlyFit’s stock price instead rises to $80. Since the put gives you the right to sell FlyFit at $65, you’d likely choose to not exercise your option when you could sell FlyFit in the market and make $80, $15 higher than your option. You’d profit from the gains in stock value, but realize $300 of losses, the cost of the put used to hedge your losses.
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The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
The examples used above are fictional, and do not constitute a recommendation or endorsement of any investment.
Options are not suitable for all investors and carry significant risk. Certain complex options strategies carry additional risk. There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, among others, as compared with a single option trade.
Prior to buying or selling an option, investors must read the Characteristics and Risks of Standardized Options, also known as the options disclosure document (ODD).
Option strategies that call for multiple purchases and/or sales of options contracts, such as spreads, collars, and straddles, may incur significant transaction costs.
Options resource center
Options Foundations
Fundamentals
Chapter 9Long call
Chapter 10Long putChapter 11Protective put
Chapter 12Covered call
Chapter 13Cash-secured putMulti-leg Strategies