Protective Put

A protective put is a strategy that can be used to protect an investment from downside risk. It involves buying a put option on the underlying asset, which gives the buyer the right, but not the obligation, to sell the asset at a specified price (the strike price) on or before a specified date (the expiration date).

If the price of the underlying asset falls below the strike price, the put option can be exercised, and the buyer will sell the asset at the strike price. This will limit the buyer's losses on the investment.

However, if the price of the underlying asset rises above the strike price, the put option will expire worthless, and the buyer will lose the premium paid for the option.

The protective put is a more expensive strategy than simply holding the underlying asset, but it can provide greater protection against downside risk.

Here is an example of how a protective put can be used to protect an investment.

Suppose an investor owns 100 shares of XYZ stock, which is currently trading at $50 per share. The investor is concerned that the price of XYZ stock could fall in the future, so they decide to buy a protective put option with a strike price of $45. The premium for the put option is $2 per share, so the investor's total investment is $200 ($2 x 100 shares).

If the price of XYZ stock falls below $45, the investor can exercise the put option and sell the stock at $45 per share. This will limit the investor's losses to $5 per share ($50 - $45).

However, if the price of XYZ stock rises above $45, the put option will expire worthless, and the investor will lose the premium paid for the option. In this case, the investor will still make a profit on their investment, but it will be less than if they had not purchased the put option.

The protective put is a versatile strategy that can be used in a variety of situations. It can be used to protect an investment from a specific downside risk, or it can be used to hedge a portfolio against a general market downturn.

The protective put is a more expensive strategy than simply holding the underlying asset, but it can provide greater protection against downside risk. Investors should carefully consider their investment objectives and risk tolerance before using the protective put strategy.