What is a Protective Put?
A Protective Put or Married Put is a risk analysis and management method that includes buying a put option through the use of a strike price similar or otherwise near to the market value of the underlying security while keeping a long put option asset (e.g., stock).
The concept of a protective put strategy is similar to that of reinsurance. The primary purpose is to prevent damages if the underlying stock's value falls unexpectedly.
Understanding Protective Put
Individuals can sell shares at strike price by purchasing a protective put. When someone is optimistic but wants to retain the investment equity price in the case of a crisis, protective puts can be helpful. However, due to market volatility, they may even reduce the risk.
As a replacement to limit proceedings, protective puts have been frequently utilized. Stop orders have the drawback of working once people do not need them and failing to operate when they just require them. For example, a stop order might get people out of a market stock early if it is rapidly changing but not genuinely falling. If this occurs, they will not be thrilled if the market goes up again soon after they sell. Alternatively, if a sharp slope occurs overnight and the share prices drop, they may not be able to exit at their stop price. Instead, they will exit at the very next accessible market rate, which might be far lower.
When someone purchases a protective put, they retain full authority over whether to activate the option or not and the value they will get for it. These advantages, meanwhile, come at a price. Individuals must persuade consumers to buy a put, while a stop order is zero. As a result, If the value increases sufficiently to repay the payments made for the put, that'd be ideal.
Practical Example
A dealer might purchase shares, as well as a 45-strike price, put for some respective amount if X is buying and selling at $50 and is predicted to move further within the next 30 days:
Purchase of 50 units of X company for $50
For $2.00, purchase 1 X 45-strike price put
If the market rises to $55 at maturity, the trader will profit $5.00 upon that share and lose $3.00 on the put since they placed $2.00 on it. The dealer would execute the 45-strike price put, trying to sell the shares at $45 if the market is down to $41 at the expiry date. They might have had a $5.00 decline on the shares, but also because they purchased the protective put at $2.00, the trader would face a $2.00 drop on the protective put.
In Sentences
- The term protective put is a financial term that is widely used to prevent any damages that could occur if the underlying stock's value falls unexpectedly.