- Zero Days to Expiration (0DTE) Options and How do They Work?
- What is an Outright Option?
- What is a basket option?
- What Are Mountain Range Options?
- What are Futures Equivalent?
- What are STIR Futures & Options: Definition, Price Quotation & Example
- Cost-of-Carry: Definition, Carry Model & Example
- What is Managed Futures Account: Definition, Advantages & Example
- What is an Outright Futures Position: Definition, Advantages, & Example
- What is a Futures Commission Merchant - Role, Obligations & Responsibilities
- Gold Futures
- What is the Fed Fund?
- What is Futures Spread
- What are shout options?
- What is a Short combination?
- What are currency derivatives?
- What are Long-dated Options?
- What are Swap Derivatives?
- What Is a Multi-Leg Options Order?
- Copper Futures
- Receiver Swaptions
- Tips for Getting Into Futures Trading
- What are market indicators?
- What is Margin Money?
- What is Short Covering?
- All About Commodity Options
- Futures and Options
- What is a Diagonal Spread and How does it work
- What is Credit Spread Strategies
- What is Box Spread trading Strategy
- What is Eurex? Understand Here!
- How are options settled?
- What are Naked Options?
- What is Option Premium
- What is Long Combo Option Trading Strategy
- What is a Cash Settlement?
- What are Oil futures
- What are Forex Options?
- What are Exchange Traded Derivatives?
- What are Equity Derivatives?
- What is Quadruple Witching
- What is Zero-Cost Collar Strategy
- What are Weekly Options?
- Synthetic Options Spread
- What are Commodity Options?
- What is Hedging with Futures?
- What is a Protective Put?
- What is call writing?
- What are Bermuda Options
- Put Writing Strategies
- What Is Call Option?
- What are Collateralized Debt Obligations?
- What is Derivative Trading?
- Options Trading Strategies: Vertical Spreads and Synthetic option spreads
- What is a fiduciary call? Understand here
- Short Put Ladder Options Strategy
- Long Call Condor Option Strategy
- Long Call Ladder Options Strategy
- Short Call Condor Options Strategy
- Short Call Ladder Options Strategy
- What are cash secured puts?
- How to Use LEAPS for Covered Call writing
- How to Calculate F&O Turnover
- Why futures prices converge upon spot prices
- What is E-mini futures
- Seagull Options
- What is Put Ratio Spread
- What is a hedging strategy?
- What is a bond option?
- What are bond futures?
- What is a derivative?
- What are commodity futures?
- Options arbitrage strategies
- What is a call ratio backspread option strategy
- Difference between warrants and calls
- What is a Short Put Butterfly option strategy
- What are over the counter (OTC) options
- How are futures prices determined
- Top 10 Mistakes when trading cheap options and how to avoid them
- How to be a successful options trader?
- What is cross currency swap
- What is expiration time in options trading?
- What is options trading?
- What are Index Futures?
- What is LTP in the Share Market?
- What is a Strike Price?
- What is Spot Price?
- What is an Underlying Asset?
- What is a Forward Contract?
- What is futures trading?
- Benefits of trading in futures
- Show all articles
What is a Protective Put?
The protective put strategy is a hedging strategy used to protect an existing long position in the market. In a protective put the holder of a security (equity or futures) buys a put option to protect himself against a drop in price.
When is a protective put used?
A protective put strategy is used when the investor is still bullish on his holdings but according to their analysis it may fall in the near term. It is also used as a means to protect unrealized gains on shares from a previous purchase.
Protective put example
Let's understand this with the help of an example. Mr. Patel already owns 300 shares of Infosys which is currently trading at ₹1,500. He feels that the share price will go higher in the long term, but could fall in the near term. So here he has 2 options:
Option 1: Sell the shares in the cash market and buy the shares when the prices dip.
Option 2: Use a protective put strategy.
Here, Mr. Patel will hold the shares and buy an out-of-the-money (OTM) put option of strike price 1,400 for a premium of ₹50. The lot size of Infosys options contracts is 300.
Therefore, total premium paid = lot size x premium = 300 x ₹50 = ₹15,000.
Note: For the purpose of profit-loss calculations, we will consider ₹1,500 as the purchase price of the underlying Infosys holding as it is the price at which the protective put strategy is deployed.
Infosys purchasing price = ₹1,500.
Premium paid = ₹50
Put strike = ₹1,400.
Cash position break even point= ₹1,500
Long put position break even point= Strike price - Premium paid= ₹1,400 - ₹50= ₹1,350
Protective put strategy break even point = Cash price + premium paid = ₹1500 + ₹50 = ₹1,550.
Scenario 1: Infosys is trading at ₹1,200 at expiry.
In this scenario, Mr. Patel will make a loss on this trade as Infosys spot price is less than the Infosys protective put strategy break even point.
Loss = (Premium paid + Purchasing price - put strike) * lot size= (50 + 1,500 - 1,400)*300 = ₹45,000.
Mr.Patel will incur a loss of ₹45,000 on this trade. His loss on the cash position is ₹90,000. However, the long put position makes a profit of ₹45,000 at this point. Thus, substantially reducing the overall loss incurred due to the fall in the share price.
Scenario 2: Infosys is trading at ₹1,500 at expiry.
Infosys traded sideways in the near term and is at ₹1,500 on expiry. In this scenario, Mr. Patel will make a loss on this trade as ₹1,500 mark is the Infosys cash position break even point but the loss is incurred only on the premium paid for the put option.
Loss = (Purchasing price - Put strike + Premium paid) * lot size= (1,500 - 1,400 + 50) * 300 = ₹15,000.
Mr.Patel will incur a loss of ₹15,000 on this trade, which is equal to the premium paid for buying the put option.
Scenario 3 : Infosys is trading at ₹1,550 at expiry.
In this scenario, Mr. Patel will neither make a profit nor a loss on this trade as ₹1,550 mark is the Infosys protective put strategy break even point.
Protective put formula for Break even point = Infosys purchasing price + premium paid = 1500 + 50 = ₹1,550.
Scenario 4: Infosys is trading at ₹1,800 at expiry.
In this scenario, Mr. Patel will make a profit as Infosys spot price is more than the protective put strategy break even point..
Protective put formula for Profit = [Infosys spot - Infosys purchasing price - premium paid ] x lot size = [1800 - 1500 - 50] x 300 = ₹75,000.
Mr.Patel will incur a profit of ₹75,000 on this trade. His profit on the cash position is ₹90,000. However, the long put position makes a loss of ₹15,000 at this point. Thus, reducing his overall profit.
Price on Expiry
|Cash position payoff||Long put payoff||
- Protective put is a hedging strategy used to protect the investor from the downside in the cash or futures market.
- It is used when the investor is still bullish on his holdings but fears that it may fall in the near term.
- Break even point formula for protective put strategy = purchasing price of the security + premium paid.
- The loss potential is limited when a protective put strategy is deployed. When the price trades below the put option break even point, the losses in the holding will be recovered by the put option.
- Profit potential is high as once the premium paid to buy the put option is recovered, the long position will yield profits as the price goes up.