Protective Put Explained

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Married Put Explained

Married or Protective puts are helpful when you want to protect the profits made from a stock, but do not want to sell it as of now to lock in the profits.

Married or Protective puts are also helpful when you bought shares and fear that the stock value may fall – but for some reason you do not want to sell the stock. Married puts will help in case the stock actually falls.

Here is a graph of married puts. If stock falls below “A” the protective puts will save the investor from losses in the stock.

Let me now explain in details.

You hold quite a lot of shares of a company and some bad news comes in about the company or about equities in general and you fear that your shares’ value may now tank. What do you do? You have two options:

1. Sell the shares at a loss, or
2. Buy ATM/OTM put of the same company.

Option 1 is pretty easy, but mostly you will lose money. Remember markets get the news before retail investors like us get. So even before you can trade, the markets will price the shares of the company you own at appropriate levels which almost always means you will be at a loss or may be breaking even (if you bought the shares at a great price.)

Even if you are not in a loss, one thing is pretty sure you lost a great amount of profits that you could have made had you sold the shares when they were at a higher level. Unfortunately greed came in and you kept it on hold. �� Well don’t worry, it happens with everyone. Nothing to feel guilty about it. If you are still in profit, my advice is that you should get out, and re-enter at a lower levels. The problem is how on earth you know if it will ever go more down and where to re-enter?

Timing the market is extremely difficult if not impossible. (Actually impossible, but they say nothing is impossible so ��

You can however protect further downside of the stock by a simple strategy called married puts. Which takes us to the second option. Buy ATM/OTM put of the same company.

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Note: Married puts are useful if you have a lot at stake in that particular stock, at least 2-3 lakhs or equivalent to its leverage in futures and options. For example right at the time of writing this article HDFC Bank is trading at Rs. 588.00 and let us suppose you bought 500 shares of HDFC Bank at 590.00. So your total investment is 500*590 = Rs. 295,000.00. The markets are falling – especially the banking sector. You fear that HDFC Bank may also fall and so you may suffer a loss, but you want to hold the stock and don’t want to sell right now and not lose money too.

You can then buy a put option of HDFC Bank to protect your losses from the downfall. Now if HDFC Bank falls, you need not worry as the put you bought will also increase in value and you can sell it at an appropriate level to realize a profit. Now your buying cost of HDFC Bank will come down due to this profit.

Three things can happen when in a married put strategy:


1. Prices moves down:
You profit from the put bought. Your cost of buying the stock comes down.
2. Prices remain at the same level: Put expires worthless. You lose the premium paid to buy it. (Worst situation.)
3. Prices move up: You profit on the stocks bought. However you lose money on the puts bought. If prices move beyond the breakeven point you will make money. The premium paid to buy the puts should be added to the cost of buying stock. This is your breakeven point. Anything beyond that is your profit.

Great. But what is the risk?

The risk is if HDFC Bank shares stays at the same level or move up. The worst situation is when they stay at the same level. Your puts will expire worthless and you will lose whatever you paid as premium to buy them. If the shares move up, you will gain some from the up move but your puts will get lower in value as the stock price moves upwards. But after your breakeven points you should be in profits.

When is a married put helpful?

You should go for married put when you are certain that the stock price of the company you hold shares in will fall in value. And you should also know the maximum risk you are wiling to take. To make married puts work its best, it is best to buy ATM or just OTM puts. If you buy too far OTM puts they may be cheap but will not increase in value fast and may actually expire worthless even if the share price drops. This will be a double whammy. You lose money in shares and you will also lose money you invested in puts as well. As in joke they will become divorced puts. �� Rather your expression will be ��

Yes taking a married put decision can bring rewards, but the risk is definitely there. You may ask why not sell futures of the same company when the stock price is going down.

Yes you may be right. Yes there are no premiums to pay and the cash also comes from the collateral from the same shares. You can use your collateral to buy options as well but at least you know your max loss when buying options. In futures you have no idea as it can be unlimited loss, so using collateral money in not a good idea.

Selling future is a better option if the stock price stays there or goes down. However what happens if there is some good news and the stock opens gap up the next day morning? You will make money in stocks you hold, but lose the same amount of money in the future. Your buying cost of the stock will go up. Unfortunately you will have to pay this as MTM (mark to margin) and if you don’t have cash your broker may sell some of your shares to pay for the losses you incurred in the future. Not a good situation to be in.

With married puts you know exactly how much you are going to lose. And if your view was wrong you may actually sell the put and restrict your losses.

It is your call, but experts always say married puts not married futures. So there is something to it.

Important Note: If you are not sure of the movement or if you think there will not be a significant drop in the share value do not attempt a married put. You may lose the premium you paid.

Protective Put

(also known as married put) is an option strategy in which an investor purchases a put option to guard against any loss on the underlying asset which he already owns. Protective put is like insurance against loss on the underlying asset.

While protective put and married put are essentially the same in concept, in protective put the option buyer already owns the underlying asset, while in married put he invests in both the underlying asset and the put option on that asset simultaneously.

Investors buy protective put when they expect the underlying stock to increase in value but at the same time they want to remove any downside risk.

Formula

Since a protective put is made up of the underlying asset and a put option on the asset, the value of the whole position must be the sum of both components as calculated by the following formula:

Value of a Protective Put = UT + max[0, X − UT]

Profit at expiration of a protective put equals the difference between the price of the underlying asset at the expiration and the price at the inception of the strategy plus the payoff from the put option minus the premium paid on the put option. This is summarized in the following formula:

Payoff from a Covered Call = UT − U0 + max[0, X − UT] − Premium

Where, UT is the price of the underlying asset at the exercise date, U0 is the price of the underlying asset at the inception of the strategy and X is the exercise price

Example

Jonathan Wong bought $100 shares of Citigroup Inc. (NYSE: C) for $30 in October 2020. The stock is currently fetching $50 per share and he is quite happy with his pick. He thinks it is more likely that the stock will go up even further in next few months. But to guard against the possibility of any drop, he bought put options on Citigroup stock. He paid $5 per option and they carry an exercise price of $50 per option.

Discuss his profit from the position if Citigroup stock price at the exercise date is (a) $100, (b) $80, (c) $50, (d) $20, and (e) 0

If Citigroup stock price at the exercise date is $0, the value of his option will be $50 [= max[0, $50 − 0]]. His total profit from the whole strategy will be -$500 as calculated using the formula below:

Profit on protective put if Citigroup stock price is 0 = 100 × ($0 − $50 + max [0, $50 – $0] – $5)

Below is the calculation of profit from the strategy at the other prices:

Profit on protective put if Citigroup stock price is $20
= 100 × ($20 − $50 + max [0, $50 − $20] − $5) = -$500

Profit on protective put if Citigroup stock price is $50
= 100 × ($50 − $50 + max [0, $50 − $50] − $5) = -$500 = -$500

Profit on protective put if Citigroup stock price is $80
= 100 × ($80 − $50 + max [0, $50 − $80] − $5) = -$2,500

Profit on protective put if Citigroup stock price is $100
= 100 × ($100 − $50 + max [0, $50 − $100] − $5) = -$4,500

The illustration just validates the plot given below for profit on protective put.

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Buying a put option gives you the right to sell stock at a fixed price within a specified time frame. A typical put option grants you to the right to sell 100 shares of stock from the investor who sells you the put option, and you have to make a decision about what to do before the option expiration date.

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DISCLAIMER: I am not a financial advisor. These videos are for educational purposes only. Investing of any kind involves risk. Your investments are solely your responsibility. It is crucial that you conduct your own research. I am merely sharing my opinion with no guarantee of gains or losses on investments. Please consult your financial or tax professional prior to making an investment.

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Protective Put Strategy

You buy stock because you’re bullish and expect the stock’s price to go up. Since you’re bullish, chances are you aren’t too preoccupied with the downside. But as we all know, markets can shift quickly. Puts are a handy tool to help lock in profits on your existing positions in the event of a sudden reversal.

Lock in profits on an existing position

Consider this example: You bought 500 shares of stock XYZ at $50, and it rises to $70. As you’re admiring your tidy potential profit, the stock drops slightly to $65. Hmm. Your first response might be, No problem. I’ll just wait until it gets back to $70, and then I’ll close out and sell. But the stock drops further to $60. Perhaps you revise your target price downward to $67, but before you know it, the stock goes back down to $50, and you’ve lost the entire run-up of potential profits. Sound familiar?

It’s an all-too-common scenario for investors: A stock makes a sudden run upwards, you get excited (and maybe a little greedy) and then it reverses before you can lock in your gains. Now consider this revised scenario: when the stock was at $70, you could’ve said to yourself, Hey, that’s an amazing run. Now I want to protect some of those potential gains. To do so, you’d buy five 60-day puts with a 65 strike price for about $2 per contract. This would cost $1,000 plus $8.20 in commissions (each put contract represents 100 shares of stock). For only a couple of bucks per share, you’d gain the right to sell your stock at $65 for the given time period — irrespective of what the actual market price per share might be.

How do protective puts work?

Why buy 65 strike puts, instead of 70 strike puts? Buying 65 strike puts should cost you considerably less than buying the 70-strike put, but the 65s still lock in most of your gains. Puts are not insurance, but think of the situation in car insurance terms: if you buy zero-deductible insurance, it usually costs a fortune. Even a small deductible lowers your premium costs substantially. That five-point difference in the two strike prices, 65 versus 70, should provide a similar benefit here.

Now let’s assume you’ve bought your five put contracts with a strike price of 65. Should your stock take a sudden dive to 50, you’d have your pick between two choices:

  1. Exercise your puts and sell the stock at $65. In this scenario, you’d keep the lion’s share of your gains: $65 — $50 = $15 x 500 shares = $7,500 less $1,008.20 for the cost of the protective put and commissions. Not a bad exit.
  2. You could also simply sell your puts for a profit and pocket the cash. (After all, if the market is currently at $50, and you’d have the right to sell at $65, the price of your puts has probably increased in value.) Selling the puts would offset a large portion of the loss on the stock and allow you to keep the long stock position, if that’s important to you longer-term. Of course, don’t forget to deduct the cost of the puts and the commissions from your profit.

What are the risks of protective puts?

As with most option trades, timing is everything with protective puts. You may purchase puts only to see the stock continue higher, which is great as a stockholder. However, you may feel as if you wasted your money by purchasing the puts after they’ve expired worthless. Furthermore, if you want to continue to protect your profits using puts, you’d have to buy more puts, pay more premiums, and incur more commissions. That protection would only last until expiration of the contracts you bought.In certain circumstances you may decide that having protection is worth the extra cost. To go back to our analogy, when you buy insurance on your car, you’re not hoping it will be stolen before the end of the term. If you’re inclined to protect your investment with puts, you should make sure the cost of the puts is worth the protection it provides. Protective puts carry the same risk of any other put purchase: If the stock stays above the strike price you can lose the entire premium upon expiration. If you renew your protection after the first puts expire by purchasing more puts, your costs can add up over time.

As long as you’re using puts judiciously and stay aware of these risks, they may offer a compelling hedge for profits on your long stock position.

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