A protective put is like buying insurance for your stocks. You pay a premium to protect against big losses while keeping your upside potential. This guide explains how protective puts work and when they make sense.
What is a Protective Put?
A protective put is when you own shares of a stock and buy a put option on that same stock. The put gives you the right to sell your shares at the strike price no matter how low the stock falls. It limits your downside while letting you keep unlimited upside.
Think of it like insurance: You pay a premium (the put cost) for protection. If something bad happens (stock crashes), you are covered. If nothing bad happens (stock stays flat or goes up), you lose the premium but your shares are fine.
How Protective Puts Work
You own 100 shares of a stock
You buy a put option on that stock
The put gives you the right to sell at the strike price
At expiration, one of two things happens:
Stock is above strike: The put expires worthless. You keep your shares and lost the premium.
Stock is below strike: You can sell shares at the strike or sell the put for profit to offset stock losses.
Example
You own 100 shares of ABC at $100 ($10,000 total value).
- Current price: $100
- You buy a $90 put for $3.00 ($300)
- This guarantees you can sell at $90 for the next 30 days
If stock drops to $70:
- Without protection: You lost $3,000 (30%)
- With protective put: You sell at $90 or the put is worth $20. Loss capped at $1,300 ($1,000 stock loss + $300 put cost)
If stock goes to $120:
- Without protection: You made $2,000
- With protective put: You made $1,700 ($2,000 - $300 put cost)
When to Use Protective Puts
- Before uncertain events: Earnings, elections, Fed meetings
- Protecting gains: You have big profits and want to lock some in
- Concentrated positions: You own a lot of one stock
- Long vacation: You will not be able to monitor your positions
- Market uncertainty: You are nervous but do not want to sell
Choosing the Right Strike Price
The strike price determines your protection level and cost:
- At the money (strike = current price): Maximum protection but expensive. Limits losses from the start.
- 5-10% below current price: Good balance. Protects against crashes but not small dips.
- 15-20% below: Cheaper but only protects against severe drops. Catastrophe insurance.
Tip: Choose a strike price below your mental stop loss. If you would sell the stock at $90 anyway, buying a $90 put makes sense. If you would hold through a 10% drop, maybe a $80 put is better.
Choosing the Right Expiration
- Short term (1-2 weeks): Cheap but needs frequent rolling
- 30-60 days: Good balance of cost and coverage
- 90+ days (LEAPS): More expensive but longer protection
The Cost of Protection
Protective puts cost money. Over time, this can eat into your returns. Here is a rough guide:
- At the money puts: 3-5% of stock value per month
- 5% out of the money: 1-3% per month
- 10% out of the money: 0.5-1.5% per month
If you always buy protective puts, you might give up 5-15% annually. This is why most investors only use them selectively, not constantly.
Protective Put vs Stop Loss
Both protect against losses, but differently:
| Protective Put | Stop Loss | |
|---|---|---|
| Cost | Premium paid | Free |
| Gap protection | Yes | No |
| Keep shares | Optional | No, sold |
| Works after hours | Yes | Limited |
The big advantage of protective puts is gap protection. If bad news hits overnight and the stock opens down 30%, your stop loss executes at the lower price. Your put is worth 30% more.
Married Put: A Variation
A married put is when you buy the stock and the put at the same time. It is essentially the same as a protective put but established together as a single trade. Tax treatment may differ, so consult a tax professional.
Rolling Your Protective Puts
As your put approaches expiration, you have choices:
- Let it expire: If you no longer need protection
- Roll it: Sell the expiring put and buy a new one with a later date
- Adjust the strike: If the stock moved up, you might buy a higher strike put
Track Your Hedged Positions
Pro Trader Dashboard shows your stock and option positions together. See your protected price, breakeven, and true exposure at a glance.
Summary
A protective put is buying a put option on a stock you own to limit downside risk. It acts like insurance: you pay a premium for protection. If the stock crashes, your losses are capped at the strike price minus what you paid for the put. If the stock rises, you keep the gains minus the put cost. Use protective puts selectively before risky events or to protect significant gains.
Want to learn more hedging strategies? Check out collar strategy to reduce the cost of protection or portfolio hedging for broader protection.