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What is a Protective Put Option?
Options are a great way to make money from short-term sales. However, one must be aware of the market and make a resilient strategy to gain profits from the options. There are definitely some risks while investing in options, but they can be minimized to a large extent. A "protective put" is a special version of the put option to let the investors earn profit without having to lose money too badly if the strategy goes wrong.
What is a protective put?
A protective put is an investment strategy that is designed to help an investor limit the losses in case of an adverse market movement. It requires the investor to buy put options of the stock they own. This way an investor can limit the losses and sometimes even negate the losses on their investment strategy.
When to use the protective put option strategy?
The stock market movements are quite unpredictable at times and investors want to hedge against the chances of downside in the price of the stock one is bullish on. This is where the protective put option strategy needs to be used. The protective put option strategy should be used only when an investor is long on a stock.
How does the protective put option work?
A protective put option works by limiting the losses or gaining from the bearish market condition.
Let’s assume that you are bullish on a stock and you buy them to gain from its profit in the future. You also buy some put options to safeguard yourself from the bearish trend if any. Now, what happens with the stocks? There are two possibilities −
Possibility 1 − The price of the stock goes up
If the price of the stock goes up, you gain from the stocks as you only have to pay the premium on the option stocks. Since the profit obtained from the sale of stock is large, you don’t have to care about the bearish option stocks.
Possibility 2 − The price of the stock goes down
When the price of your stock goes down, you can get the benefit from the bearish put option. As the put option on your stock offers the gains, your net profit will be positive due to the cushioning from the put options.
The protective put strategy is a good way to save yourself from unnecessary risks that may arise due to volatile market conditions. As it is easy to deal with both bullish and bearish markets with a protective put, the strategy is beneficial for both long and short-term investors.
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