Protective Put with Shares – This strategy involves owning shares of a stock while buying open 1 put for every 100 shares owned. Buying open a put at a strike price gives the right to sell 100 shares of that stock at that price should the stock price decrease significantly, thus limiting losses while still allowing gains to the upside with shares.
The protective put is for those who investors who are into more volatile stocks, such as stocks on biotech and internet companies. The best thing about the protective put is the continued potential for unlimited reward. The way the protective put works is that investors use it as part of their overall strategy. They can therefore create a position for their investments as the market moves in various directions.
As an insurance play, the protective put is very affordable and simple. For every 100 shares of stock you have, all you have to do is to buy one protective put at strike price below the current price per share. Or you can buy two protective puts that are below the current market price of the stocks. Supposing you bought stock ABC at $100, you can then buy a $95 or $90 put. So, if the stocks take a dive, you will then be able to sell the stock in the amount that is closest to what you originally paid for them. Now, if the stock surges, you can take advantage of the upswing minus the amount of the protective put. The put then is like an insurance for your stocks.
For example, supposing stocks ABC is trading at $10,000. To buy 100 shares, you need $10000. Now, if you purchase it for that amount your downside risk is $10000, which is what you paid for the shares. However, your upside reward is unlimited. If you want to limit the amount you can lose if the stocks fall, then you can buy one protective put since one protective put covers 100 shares. Take a look at the following:
|ABC trading @ $100.00|
|Buy 100 ABC @ $100.00||$10,000.00|
|Buy ABC 90 Put @ $2.00||$200.00|
|Cost of Trade||$10,200.00|
It does not matter how far your stock drops, you might consider selling the option before expiration. By doing that, you will be able to lock in your profit. If the price of the stocks suddenly rose from $100 to $110+, then the 90 put will not provide much downward protection. This is the reason why it is prudent to lock in profits by rolling the puts to up to 100 or close to 100.
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