Protective Puts Summary

The potential volatility of the marketplace can present great risk to stock investors, but purchasing protective puts can give investors the comfort level needed to purchase individual securities. This strategy may be viewed as more conservative than a simple stock purchase because as long as a put is held against an underlying stock position there is limited downside risk. The primary benefit of this strategy is that it provides a downside guaranteed selling price. That is to say an investor knows at what price shares can be sold no matter how low the stock's price drops. On the other hand, the protective put does not place a cap on how high the stock can be sold. The protective put holder enjoys unlimited upside profit potential as the price of the underlying stock continues to increase, and as long as the shares are owned he continues to receive any dividends paid to shareholders.

As with any long option position, an investor pays premium for the protective put and its many benefits. The result is an increased break-even point for the underlying shares that are owned equal to the combined cost of the stock and the put. If at any point while owning the put the investor decides that further protection on the shares is not needed, the put may be sold if it has market value, and possibly at a profit.

Buying an at-the-money put or one of possibly several out-of-the-money contracts that might be available can have different advantages and risks. For most underlying stocks there will be a listed put contract with a strike price and expiration month that optimally fits the balance of risk vs. reward an investor is looking for. Keeping in mind that protective puts do expire, sometimes before they provide any insurance value, a put buyer might turn to a LEAPS ® put contract which can have a lifetime of up to three years. Alternatively, an investor might choose to "roll" a shorter-term protective put position by selling an existing put position and purchasing another with a different expiration month and possibly a different strike price.