# Protective Put Options: A Guide to Risk Management

![Protective Put: Buying a put option on an asset an investor owns to guard against a drop in its price.](https://www.investopedia.com/thmb/qgzoqHRezC9bQ62mqmk8nmhAH6U=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Protective-put_final-303f41ce3dcb4f0abe6997d5f373a130.png)

*— Investopedia / Michela Buttignol*

## What Is a Protective Put?

A protective put is a versatile risk-management strategy for investors wanting to protect their investments against potential stock or asset losses. By purchasing a [put option](https://www.investopedia.com/terms/p/putoption.asp), investors can hedge against downturns while retaining the possibility of profiting from upward movements, making it an essential tool in an investor's portfolio.

### Key Takeaways

*   A protective put is an options strategy that serves as a form of insurance to limit the downside risk of a stock investment.
*   It involves buying a put option to protect against losses while allowing for potentially unlimited gains if the underlying asset appreciates.
*   The cost of this downside protection is the premium paid for the put option, which can lower overall profits.
*   Protective puts are commonly used when investors are bullish on an asset but want to hedge against unexpected declines.  
    

## Understanding the Mechanics of Protective Puts

Protective puts are commonly utilized when an investor is [long](https://www.investopedia.com/terms/l/long.asp) or purchases shares of stock or other assets that they intend to hold in their portfolio. Typically, an investor who owns stock has the risk of taking a loss on the investment if the stock price declines below the purchase price. Buying a put option limits potential stock losses.

The protective put creates a floor price, preventing further losses if the asset price drops.

A put option is a contract that gives the owner the ability to sell a specific amount of the [underlying security](https://www.investopedia.com/terms/u/underlying-security.asp) at a set price before or by a specified date. Unlike futures contracts, the options contract does not obligate the holder to sell the asset and only allows them to sell if they should choose to do so. The set price of the contract is known as the strike price, and the specified date is the expiration date or expiry. One option contract equates to 100 shares of the underlying asset.

Also, just like all things in life, put options are not free. The fee on an option contract is known as the premium. This price has a [basis on several factors](https://www.investopedia.com/articles/active-trading/112213/getting-handle-options-premium.asp) including the current price of the underlying asset, the time until expiration, and the [implied volatility](https://www.investopedia.com/terms/i/iv.asp) (IV)—how likely the price is going to change—of the asset.

## Exploring Strike Prices and Premiums in Protective Puts

A protective put option contract can be bought at any time. Some investors buy these while purchasing the stock. Others may wait and buy the contract at a later date. Whenever they buy the option, the relationship between the price of the underlying asset and the strike price can place the contract into one of three categories—known as the [moneyness](https://www.investopedia.com/terms/m/moneyness.asp). These categories include:

1.  At-the-money (ATM) where strike and market are equal
2.  Out-of-the-money (OTM) where the strike is below the market
3.  In-the-money (ITM) where the strike is above the market

Investors looking to hedge losses on a holding primarily focus on the ATM and OTM option offerings.

Should the price of the asset and the strike price be the same, the contract is considered [at-the-money](https://www.investopedia.com/terms/a/atthemoney.asp) (ATM). An at-the-money put option provides an investor with 100% protection until the option expires. Many times, a protective put will be at-the-money if it was bought at the same time the underlying asset is purchased.

Investors can buy [out-of-the-money](https://www.investopedia.com/terms/o/outofthemoney.asp) (OTM) put options too. Out-of-the-money means the strike price is below the asset's current price. An OTM put option does not provide 100% protection on the downside but instead caps the losses to the difference between the purchased stock price and the strike price. Investors use out-of-the-money options to reduce premium costs while accepting some potential loss. Also, the further below the market value the strike is, the less the premium will become.

For example, an investor could determine they're unwilling to take losses beyond a 5% decline in the stock. An investor can buy a put option with a strike price 5% lower, ensuring only a 5% loss if the stock falls. Different strike prices and expiration dates are available for options giving investors the ability to tailor the protection—and the premium fee.

> **Important**
>
> A protective put is also known as a married put when the options contracts are matched one-for-one with shares of stock owned.

## Potential Outcomes of Using Protective Puts

A protective put keeps downside losses limited while preserving unlimited potential gains to the upside. However, the strategy involves being long the underlying stock. If the stock keeps rising, the long stock position benefits and the bought put option is not needed and will expire worthlessly. All that will be lost is the premium paid to buy the put option. In this scenario where the original put expired, the investor will buy another protective put, again protecting their holdings.

Protective puts can cover a portion of an investor's long position or their entire holdings. When the ratio of protective put coverage is equal to the amount of long stock, the strategy is known as a [married put](https://www.investopedia.com/terms/m/marriedput.asp).

Married puts are commonly used when investors want to buy a stock and immediately purchase the put to protect the position. However, an investor can buy the protective put option at any time as long as they own the stock.

![Married Put Options Strategy](https://www.investopedia.com/thmb/sam_HlNu9AGiT2aIppsaCiJTssI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/10OptionsStrategiesToKnow-02_2-8c2ed26c672f48daaea4185edd149332.png)

**

The maximum loss of a protective put strategy is limited to the cost of buying the underlying stock—along with any commissions—less the strike price of the put option plus the premium and any commissions paid to buy the option.

The strike price of the put option acts as a barrier where losses in the underlying stock stop. The ideal situation in a protective put is for the stock price to increase significantly, as the investor would benefit from the long stock position. In this case, the put option will expire worthlessly, the investor will have paid the premium, but the stock will have increased in value.

Pros

*   For the cost of the premium, protective puts provide downside protection from an asset's price declines.
    
*   Protective puts allow investors to remain long a stock offering the potential for gains.
    

Cons

*   If an investor buys a put and the stock price rises, the cost of the premium reduces the profits on the trade.
    
*   When the stock price drops, the premium increases losses if a put was bought.
    

## Application of Protective Puts

Let's say an investor purchased 100 shares of General Electric Company ([GE](https://www.investopedia.com/markets/quote?tvwidgetsymbol=ge)) stock for $10 per share. The price of the stock then increased to $20, giving the investor $10 per share in unrealized gains—unrealized because it has not been sold yet.

The investor does not want to sell their GE holdings, because the stock might appreciate further. They also do not want to lose the $10 in unrealized gains. The investor can purchase a put option for the stock to protect a portion of the gains for as long as the option contract is in force.

The investor buys a put option with a strike price of $15 for 75 cents, which creates a worst-case scenario of selling the stock for $15 per share. The put option expires in three months. If the stock falls back to $10 or below, the investor gains on the put option from $15 and below on a dollar-for-dollar basis. In short, anywhere below $15, [the investor is hedged until the option expires](https://www.investopedia.com/ask/answers/061715/how-do-traders-combine-short-put-other-positions-hedge.asp).

The option premium cost is $75 ($0.75 x 100 shares). As a result, the investor has locked in a minimum profit equal to $425 ($15 strike price - $10 purchase price =$5 - $0.75 premium = $4.25 x 100 shares = $425).

To put it another way, if the stock declined back to the $10 price point, unwinding the position would yield a profit of $4.25 per share, because the investor earned $5 in profit—the $15 strike less $10 initial purchase price—minus the 0.75 cents premium.

If the investor didn't buy the put option, and the stock fell back to $10, there would be no profit. On the other hand, if the investor bought the put and the stock rose to $30 per share, there would be a $20 gain on the trade. The $20 per share gain would pay the investor $2,000 ($30 - $10 initial purchase x 100 shares = $2000). The investor must then deduct the $75 premium paid for the option and would walk away with a net profit of $1925.

Of course, the investor would also need to consider the commission they paid for the initial order and any charges incurred when they sell their shares. For the cost of the premium, the investor has protected some of the profit from the trade until the option's expiry while still being able to participate in further price increases.

Finally, the investor should realize that the $75 premium for the put is essentially the cost of insurance on the position. One could argue that they would have been better off not buying the put at all if it remains above $10. However, as with all insurance, it provides peace of mind and protection in the case of an adverse event.

## The Bottom Line

A protective put serves as an insurance strategy for investors who wish to protect against potential losses while still benefiting from the upside potential of owning a stock. By purchasing a put option, investors can effectively cap their losses, offering peace of mind in volatile markets.

Though the premium costs can reduce total profits, this strategy ensures that investors maintain control over their risk exposure. While protective puts can be applied to various assets, employing them effectively in your portfolio can safeguard your investments during market downturns.