What it means
The strategy pairs a long position in the shares with a long put on the same shares, which is why it is sometimes called a married put when both are bought at the same time. The put gains value as the share price falls, offsetting the loss on the shares below the strike, so the combined position has a floor.
Above the strike, the put simply expires worthless and you keep the gain on the shares less what the protection cost. The natural comparison is with an insurance policy, and the analogy holds unusually well.
The strike price behaves like the level at which cover starts, the gap between the current price and the strike behaves like a deductible you bear yourself, and the premium is the cost of the policy. A higher strike costs more and protects sooner, exactly as a lower deductible costs more on any insurance product.
Businesses and individuals use it when they hold a concentrated position they cannot or do not want to sell. Founders locked up after a listing, executives with vested but restricted shares, and companies holding stock received in an acquisition all face real downside risk with no easy exit.
A protective put converts an unbounded exposure into a known, budgeted cost. Cost is the honest drawback, and it compounds if the strategy is repeated.
Buying protection continuously through rolling puts can consume several per cent of the position's value each year, which is a heavy drag if the shares merely drift sideways. This is why many holders instead use a collar, selling a call above the market to fund the put, accepting a cap on the upside in return for cheaper or zero-cost protection.
Two mechanics are worth understanding before using it. Option premiums rise sharply with implied volatility, so protection is most expensive exactly when people most want it, and time decay means the premium erodes as expiry approaches whether or not the share price moves.
Buying protection during a calm period for an event several months away is generally far cheaper than buying it during a panic.
In practice
Real-world examples.
Example
A founder holds $4,000,000 of shares in the company that acquired her business and is contractually barred from selling for a year. She buys puts 10% below the current price for around 4% of the position's value, capping her worst case while keeping the upside.
Example
A treasury team holds listed shares received as part-consideration in a disposal and needs certainty about the cash they will realise in nine months. Protective puts let them build the minimum proceeds into the budget with confidence.
Example
An investor with a large technology holding is nervous ahead of an earnings announcement but does not want to sell and trigger a capital gain. He buys one-month puts covering the announcement date, treating the premium as the price of sleeping through the week.
Think of it
“Protective put is insurance for your stock-buying puts to protect against decline.
Formula
Calculation
For a protective put: Maximum loss per share = (Purchase price - Strike price) + Premium, and Breakeven = Purchase price + Premium. Take an investor holding 1,000 shares bought at $50, a position worth $50,000. She buys 1,000 shares' worth of puts with a $45 strike, paying a $3 premium per share, so the protection costs 1,000 x $3 = $3,000. Her maximum loss is ($50 - $45) + $3 = $8 per share, or $8,000 in total, and her breakeven on the upside is $50 + $3 = $53. If the shares crash to $30, the holding is worth $30,000 while the put is worth ($45 - $30) x 1,000 = $15,000, giving $45,000 before the premium and $42,000 after it, a loss of $8,000 rather than the $20,000 she would have lost unprotected. If instead the shares rise to $60, the put expires worthless and she nets $60,000 - $3,000 = $57,000.Case study
Seen in the real world.
Pellworth Marine is a fictional company invented for this illustrative case study. After selling its shipyard division, it received $12,000,000 of listed shares in the buyer, subject to a twelve-month lock-up, and had already committed that money to a new facility due to begin construction the following year.
The finance director was uncomfortable carrying construction commitments against an asset that could fall 40% in a bad quarter. She bought twelve-month puts at a strike 15% below the market price for a premium of about 5% of the position, roughly $600,000, which set a floor of about $9,600,000 on the eventual proceeds before the premium cost.
In this illustrative example the shares actually rose 22% over the year, the puts expired worthless and the $600,000 was spent for nothing in hindsight. The board nonetheless judged it money well spent, on the reasoning that the alternative was funding a committed capital project from an asset whose worst case they could not survive, which is exactly the situation insurance exists for.
Watch out
Common mistakes.
- Treating the premium as wasted when the shares rise. The premium buys a defined worst case for a fixed period, and an unused insurance policy is not a failed one.
- Buying protection only after a sharp fall. Implied volatility spikes during selloffs, so the premium is at its most expensive exactly when the fear is greatest.
- Forgetting the gap between the current price and the strike. A put struck 10% below the market means the holder still absorbs that first 10% of the decline before any protection begins.
Questions
People also ask.
What is the difference between a protective put and a collar?
A collar adds a sold call above the market to fund the put, which reduces or eliminates the net premium but caps the upside.
Does a protective put cap potential gains?
No, the shares can appreciate without limit, and the only reduction to the upside is the premium paid for the put.
How is the strike price chosen?
By deciding how much decline the holder can tolerate unprotected, since a higher strike gives protection sooner at a higher premium and a lower strike is cheaper with a larger self-borne loss.
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