Protective Put

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There are typically two different reasons why an investor might choose the protective put strategy. A protective put position is created by buying or owning stock and buying put options on a share-for-share basis.

In the example, shares are purchased or owned and one put is purchased. If the stock price declines, the purchased put provides protection below the strike price. The protection, however, lasts only until the expiration date. If the stock price rises, managing long put options explained investor participates fully, less the cost of the put. Potential profit is unlimited, because the underlying stock price can rise indefinitely.

However, the managing long put options explained is reduced by the cost of the put plus commissions. Risk is limited to an amount equal to stock price minus strike price plus put price plus commissions. In the example above, the put price is 3. The maximum risk, therefore, managing long put options explained 3. This maximum risk is realized if the stock price is at or below the strike price of the put at expiration.

If such a stock price decline occurs, then the put can be exercised or sold. See the Strategy Discussion below. The protective put strategy requires a 2-part forecast. First, the forecast must be bullish, which is the reason for buying or holding the stock. Second, there must also be a reason for the desire to limit risk. Perhaps there is a pending earnings report that could send the stock price sharply in either direction. In this case, buying a put to protect a stock position allows the investor to benefit if the report is positive, and it limits the risk of a negative report.

Alternatively, an investor could believe that a downward trending stock is about to reverse upward. In this case, buying a put when acquiring shares limits risk if the predicted change in trend does not occur. Buying a put to limit the risk of stock ownership has two advantages and one disadvantage. The first advantage is that risk is limited during the life of the put.

Second, buying a put to limit risk is different than using a stop-loss order on the stock. Whereas a stop-loss order is price sensitive and can be triggered by a sharp fluctuation in the stock price, a long put is limited by time, not stock price. The disadvantage of buying a put is that the total cost of the stock is increased by the cost of the put.

If the stock price is below the strike price at expiration, then a decision has to be made whether to a sell the put and keep the stock position unprotected, b sell the put and buy another put, thus extending the protection, or c exercise the put and sell the stock and invest the funds elsewhere.

The total value of a protective put position stock price plus put managing long put options explained rises when the price of the underlying stock rises and falls when the stock price falls. The value of a long put changes opposite to changes in the stock price. When the stock price rises, the long put decreases in price and incurs a loss.

And, when the stock price declines, the long put managing long put options explained in price and earns a profit. Put prices generally do not change dollar-for-dollar with changes in the price of the underlying stock.

In a protective put position, the negative delta of the long put reduces the sensitivity of the total position to changes in stock price, but the net delta is always positive. Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to managing long put options explained remain constant. A long put, therefore, benefits from rising volatility and is hurt by decreasing volatility.

As a result, the total value of a protective put position will increase when managing long put options explained rises and decrease when volatility falls.

This is known as time erosion. Since long puts decrease in value and incur losses when time passes and other factors remain constant, the total value of a protective put position decreases as time passes and other factors remain constant. Stock options in the United States can be exercised on any business day, and the holder long position of a stock option position controls when the option will managing long put options explained exercised. Since a protective put position involves a long, or owned, put, there is no risk of early assignment.

If a put is exercised, then stock is sold at the strike price of the put. In the case of a protective put, exercise means that the owned stock is sold and replaced with cash. Therefore, if an investor with a protective put position does not want to sell the stock when the put is in the money, the long put must be sold prior to expiration.

There are important tax considerations in a protective put strategy, because the timing of protective put can affect managing long put options explained holding period of the stock. As a result, the tax rate on the profit or loss from the stock can be affected.

Investors should seek professional tax advice when calculating taxes on options transactions. If a stock is held for more than one year before it is sold, then long-term rates apply, regardless of whether the put was managing long put options explained at a profit or loss or expired worthless.

If a stock is owned for less than one year when a protective put is purchased, then the holding period of the stock starts over for tax purposes. However, if a stock is owned for more than one year when a protective put is purchased, then the gain or loss on the stock is considered long-term regardless of whether the put is exercised, sold at a profit or loss or expires worthless.

Long put - speculative. In return for paying a premium, the buyer of a put gets the right not the obligation to sell the underlying instrument at the strike price at any time until the expiration date. A collar position is created by buying or owning stock and by simultaneously buying protective puts and selling covered calls on a share-for-share basis. Reprinted with permission from CBOE. The statements and opinions expressed in this article are those of the author.

Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options.

Supporting documentation for any claims, if applicable, will be furnished upon request. Charts, screenshots, company stock symbols and examples contained in this module are for illustrative purposes only. Skip to Main Content. Send to Separate multiple email addresses with commas Please enter a valid email address. Your email address Please enter a valid email address. Related Strategies Long put - speculative In return for paying a premium, the buyer of managing long put options explained put gets the right not the obligation to sell the underlying instrument at the strike price at any time until the expiration date.

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A long put gives you the right to sell the underlying stock at strike price A. If there were no such thing as puts, the only way to benefit from a downward movement in the market would be to sell stock short. But when you use puts as an alternative to short stock, your risk is limited to the cost of the option contracts.

But be careful, especially with short-term out-of-the-money puts. If you buy too many option contracts, you are actually increasing your risk. Options may expire worthless and you can lose your entire investment. Puts can also be used to help protect the value of stocks you already own. These are called protective puts. A general rule of thumb is this: You can learn more about delta in Meet the Greeks. Try looking for a delta of -. In-the-money options are more expensive because they have intrinsic value, but you get what you pay for.

If the stock goes to zero you make the entire strike price minus the cost of the put contract. For this strategy, time decay is the enemy. It will negatively affect the value of the option you bought. After the strategy is established, you want implied volatility to increase. Options involve risk and are not suitable for all investors. For more information, please review the Characteristics and Risks of Standardized Options brochure before you begin trading options.

Options investors may lose the entire amount of their investment in a relatively short period of time. Multiple leg options strategies involve additional risks , and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies.

Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or the probability of reaching a specific price point. The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract.

There is no guarantee that the forecasts of implied volatility or the Greeks will be correct. Ally Invest provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. System response and access times may vary due to market conditions, system performance, and other factors.

Content, research, tools, and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results and are not guarantees of future results.

All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. The Options Playbook Featuring 40 options strategies for bulls, bears, rookies, all-stars and everyone in between.

The Strategy A long put gives you the right to sell the underlying stock at strike price A. Maximum Potential Loss Risk is limited to the premium paid for the put. Ally Invest Margin Requirement After the trade is paid for, no additional margin is required. As Time Goes By For this strategy, time decay is the enemy.

Implied Volatility After the strategy is established, you want implied volatility to increase. Use the Technical Analysis Tool to look for bearish indicators. Break-even at Expiration Strike A minus the cost of the put. The Sweet Spot The stock goes right in the tank.