Protective Put Strategy is a hedging strategy where trader guards himself from the downside risk. This strategy is adopted when a trader is long on the underlying asset but skeptical of the downside. He will buy one ATM Put Option to hedge his position. Now, if the underlying asset moves either up or down, the trader is in a safe position.
This strategy is similar to Short Straddle; the only difference is of the strike prices at which the positions are built. Short Strangle involves selling of one OTM Call Option and selling of one OTM Put Option, of the same expiry date and same underlying asset. Here the probability of making profits is more as there is a spread between the two strike prices, and if ..
Lower Break-even = Strike Price of Put - Net Premium, Upper Break-even = Strike Price of Call+ Net Premium
PROTECTIVE PUT Vs SHORT STRANGLE - When & How to use ?
PROTECTIVE PUT
SHORT STRANGLE
Market View
Bullish
Neutral
When to use?
This strategy is adopted when a trader is long on the underlying asset but skeptical of the downside.
This strategy is perfect in a neutral market scenario when the underlying is expected to be less volatile.
Action
Buy 1 ATM Put
Sell OTM Call, Sell OTM Put
Breakeven Point
Purchase Price of Underlying + Premium Paid
Lower Break-even = Strike Price of Put - Net Premium, Upper Break-even = Strike Price of Call+ Net Premium
PROTECTIVE PUT Vs SHORT STRANGLE - Risk & Reward
PROTECTIVE PUT
SHORT STRANGLE
Maximum Profit Scenario
Price of Underlying - Purchase Price of Underlying - Premium Paid
Maximum Profit = Net Premium Received
Maximum Loss Scenario
Premium Paid + Purchase Price of Underlying - Put Strike + Commissions Paid
Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received
Risk
Limited
Unlimited
Reward
Unlimited
Limited
PROTECTIVE PUT Vs SHORT STRANGLE - Strategy Pros & Cons
PROTECTIVE PUT
SHORT STRANGLE
Similar Strategies
Long Call, Call Backspread
Short Straddle, Long Strangle
Disadvantage
• Value of protective put position decreases as time passes • Holding period of the protective put can be affected by the timing as a result tax rate on the profit or loss from the stock can be affected.
• Unlimited loss is associated with this strategy, not recommended for beginners. • Limited reward amount.
Advantages
• Unlimited potential profit due to indefinitely rise in the underlying stock price . • This strategy allows you to hold on to your stocks while insuring against losses. • Hedging strategy, trader can guard himself from the downside risk.
• Higher chance of profitability due to selling of OTM options. • Advantage from double time decay and a contraction in volatility. • Traders can book profit when underlying asset stays within a tight trading range.
