Stocks With A Protective Put
Stocks on their own represent an undefined risk. Take a bold stance on the direction of a stock and sleep easier knowing that your risk is limited. Define the parameters of risk and/or remove the risk of ownership to a defined cost by combining the purchase of shares of stock with a protective put. Take a bearish stance and define your risk by shorting the stock with a protective call. More advanced methodologies utilize collars, and delta hedging to adjust to the unique circumstances of the current market environment. Join us live on line, or watch the archived recording.
Buying protective puts on stocks is an effective way of quantifying risk, an alternative to using stop loss orders and a method of repositioning yourself on long term holdings.
In order to buy a protective put you must buy or already own the shares of the stock. You then buy 1 put for every 100 shares you hold. This gives you the right to sell your shares at a specific price known as a strike price over a specific period of time.
Let’s review the benefits of using protective puts over stop loss orders. The first risk of traditional stop loss orders is the risk of market volatility. You could purchase shares and just use a traditional stop loss order with no protective put but get whipped out of the market by your own stop loss order or even worse get stopped out becuase of a market open price gap where the stock price had fallen overnight to below your stop and your actual order gets filled at a lesser amount than your stop loss….only to have the shares rebound leaving you sitting on the sidelines with a realized loss.
With a protective put there is no volatility stop out risk. You have a guaranteed strike price exit with the only disadvantage being the upfront cost to purchase the “stock insurance” aka protective put.
Compare using the standard average down strategy with and without using options.
Traditionally investors buy more shares at the lower market price to offset the higher price paid earlier and reduce the overall cost per share by averaging. Using protective puts as an alternative to averaging down you would either sell your shares at the put strike price and buy back your shares at the new lower price or sell your puts at a profit and use the proceeds to buy more shares at the lower price.
Why Hedge Your Risk With Puts?
When you buy protective puts it prevents that feeling of being trapped in a losing position and prevents you from turning a short term trade into a long term holding and and gives you the control to re-position to reduce your cost basis or lock in your profits.
Check out this example from a blog Patrick wrote for the Montreal Exchange Insurance For Your Insurance Stocks
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