What is a Protective Put? A Simple Guide
A protective put is a hedging strategy where an investor holding the underlying buys a put option to limit downside risk. The put acts like insurance, setting a floor below which losses are capped. The cost is the premium paid for the put.
A protective put is insurance for a stock you own. You buy a put so that if the stock falls, the put gains value and cushions the loss.
Here is how it works, why it matters, and what to watch for. You can trade it on Stockk.
Key Takeaways
- You hold the stock and buy a put to protect it.
- The put floors your downside loss.
- The upside stays open, minus the premium.
- The cost is the put premium, like insurance.
- It suits investors wanting to stay invested but hedged.
How does a protective put work?
You keep your long position while buying a put that gains value as the underlying falls, offsetting the decline below the strike. This sets a floor on losses while leaving the upside open. The premium paid is the cost of this insurance.
For example, you hold a stock at ₹100 and buy the ₹95 put for a ₹3 premium. If the stock falls below ₹95 the put gains value and floors your loss at ₹8, which is the ₹5 fall to the strike plus the ₹3 premium. If the stock rises, the upside stays open, though the ₹3 cost lifts your breakeven to ₹103.
When investors use protective puts
Protective puts suit investors who want to stay invested but guard against a sharp fall, such as before uncertain events. The strategy preserves upside while capping downside, at the cost of the premium. It is a direct way to hedge a holding without selling it.
Protective put at a glance
| Item | Protective put |
|---|---|
| Downside | Floored below the put strike |
| Upside | Open, minus the premium |
| Cost | The put premium |
| Best when | You want to stay invested but hedged |
When you are ready to trade protective put and other strategies, Stockk has you covered. Create a demat account in minutes and lean on the Knowledge Center as you build confidence.
Futures and Options are leveraged products and carry a high risk of loss that can be more than the money you put in. This article is only for learning and is not a recommendation to trade in derivatives.
Frequently Asked Questions
How does a protective put limit risk?
The put gains value as the underlying falls, flooring losses below the strike, so the downside is capped while the upside stays open.
What is the cost of a protective put?
It is the premium paid for the put, like an insurance fee, which reduces net returns slightly but buys downside protection.
When should I use a protective put?
When you want to stay invested but guard against a sharp fall, often before events. It hedges downside while preserving upside.
Does a protective put cap my upside?
No, the upside stays open, reduced only by the premium cost, unlike a covered call which caps gains.
Is a protective put worth the cost?
It depends on how much you value protection against a fall, with the premium as the trade-off.
Investments in securities market are subject to market risks. This article is for educational purposes only and does not constitute investment advice.
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