Protective Put: A Guide to Risk Management

A protective put is an options strategy that acts like insurance on a long stock (or other asset) position. By buying a put option while holding the underlying asset, an investor limits downside risk while preserving upside potential.

Key takeaways

• A protective put protects against declines in the underlying asset by giving the right to sell at a specified strike price.
• The cost of protection is the option premium, which reduces net profit if the asset rises.
• Protective puts are useful when you’re bullish on an asset’s upside but want to guard against unexpected drops.
• A one-to-one position (one put per 100 shares) is called a married put.

How it works

• Buy and hold the underlying asset (e.g., shares).
• Buy a put option on that asset. One standard option contract typically covers 100 shares.
• The put gives the holder the right (not the obligation) to sell the asset at the strike price on or before expiration.
• If the asset falls below the strike, the investor can exercise the put (or sell the put) to offset losses. If the asset rises, the put may expire worthless and the investor keeps the upside minus the premium paid.

Strike price, moneyness, and premium trade-offs

When choosing a put, investors consider:
* Moneyness:
* At-the-money (ATM): strike ≈ current market price — provides the most direct protection but costs more.
* Out-of-the-money (OTM): strike < market price — cheaper premiums but allows some downside before protection kicks in.
* In-the-money (ITM): strike > market price — stronger protection but highest premium.
* Expiration: longer expirations cost more but protect for a longer period.
* Premium drivers: underlying price, time to expiration, implied volatility, and interest/dividends.
Trade-off: higher protection (higher strike, longer term) → higher premium.

Potential outcomes and costs

• Upside scenario: If the underlying rises, you benefit from the price appreciation; the put likely expires worthless and the premium is the cost of insurance.
• Downside scenario: If the underlying falls below the strike, losses are limited because you can sell at the strike (or realize gains in the put).
• Maximum loss (ignoring commissions/taxes): purchase price of the stock − strike price + premium.
• Coverage sizing: you can hedge part of a position (buy fewer puts) or fully hedge (married put = one put per 100 shares).

Pros:
* Caps downside risk while keeping upside exposure.
* Flexible—can be bought when initiating a position or added later.

Cons:
* Premium reduces net returns if the stock rises.
* Repeatedly buying protection can be expensive in volatile markets.

Example

An investor bought 100 shares at $10 (cost $1,000). The shares rise to $20, creating $1,000 unrealized gain. To protect profits, the investor buys a 3‑month put with a $15 strike for $0.75 per share (premium $75 total).
* Worst-case sale price if exercised: $15. Net worst-case profit per share = $15 − $10 − $0.75 = $4.25 → $425 total.
* If the stock falls back to $10, exercising the put preserves the $425 profit; without the put, the position would have no profit.
* If the stock rises to $30, gross gain = $20 per share ($2,000), minus the $75 premium → $1,925 net gain.

When to use a protective put

• You want to hold a position for potential upside but seek downside certainty for a defined period.
• You expect short-term volatility but remain bullish long term.
• You want peace of mind (insurance) for large unrealized gains or a concentrated holding.

Bottom line

A protective put is a straightforward hedge that limits downside while preserving upside potential. It’s a useful tool for investors who want to maintain long exposure but reduce tail risk. The main cost is the premium; selecting the appropriate strike and expiration balances protection level against cost.