Low-Risk Options Strategy: The Protective Put

One lesser-known investment strategy is the Protective Put strategy, which involves purchasing or holding a stock and buying a put option to protect against the downside.The strategy is the opposite of the Covered Call Strategy because the investor is limiting their downside and leaving the upside potential of the position. This type of protection does come at a cost, such as purchasing insurance against a loss; an individual must pay a premium in order to receive the protection. The amount of premium that an investor pays depends on the volatility within the individual stock, the higher the volatility of the stock, the more premium that an investor will have to pay for the “insurance”.

Figure 3 is a fictitious trade involving the purchasing or holding of 100 shares of Google, Inc (GOOG) on March 22, 2007. The reason for this hedge was Google planned to announce earnings after the bell on April 19, 2007, and to hedge against any downside risk the investor purchased a $470 put option, limiting the total risk of loss to $1,750 while maintaining the unlimited upside potential minus the $15.60 put option premium.

Figure 3