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As the name itself suggests, the Protective Put strategy is used by investors to protect their capital gains from a decline in the stock price. Investors buy put options for a given premium to hedge their positions. In this strategy, investors buy put option contracts to hedge against a potential fall in stock price. This strategy is generally used when investors have made profits from stock price appreciation and want to hold stock further but do not want to risk their earnings from a decline in stock price again. This strategy is similar to the most widely used covered call strategy. The objective is the same in both the strategy; however, the significant difference lies in the execution. In a covered call, you write call option contracts while protective puts you buy put option contracts. From a profit/loss standpoint, a trader gets paid to open a covered call; there is a net cash outflow in case of protective puts.
Trading with MS excel
Below is a screenshot of the complete excel template that marketXLS provides for this strategy. This template has five major components. Let’s break them down one by one.
Input by user
In this section, you put the stock ticker and the expiry for the option of that underlying. You can select the expiry from section 2. Here, we have taken the example of AAPL (Apple Inc.) with an expiry of 19 Feb 2021.
A protective put is one of the most straightforward strategies in options trading as it involves only one leg of buying an OTM put option contract. As I am writing this article, AAPL shares are trading at $125. Therefore, an investor would buy a put option out-the-money, say $135. The investor pays a premium of $145 to the writer. This is the maximum loss he would incur in this trade.
Profit, loss, and breakeven
The table and the graph below show how the trade will pan out at various AAPL stock prices. As you can see, had the investor not bought put options, the loss would have been significant on the bearish side and it only increases with the stock price. The execution of a protective put helped the investor to limit his losses to a mere $145. However, the profits are unlimited on the bullish side. The breakeven point is at the strike price, which is $135.
• A protective put is a high volatility strategy as the losses are limited on the bearish side, and the profits are unlimited on the bullish side.
• Since protective put is pretty straightforward, it is also suitable for beginners.
• Loss is limited to just the premium, while profit is unlimited on the bullish side.
• An investor pays a premium upfront to open a trade with this strategy.
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Learn more about protective put here.