Protective Put

A protective put works like insurance. The investor keeps all the upside if the share price rises, minus the cost of the put, but is protected from losses below the put's strike price.

For example, an investor owns shares trading at 50 and buys a put with a strike price of 45 for a premium of 2. If the share falls to 30, the investor can sell at 45. Their maximum loss is limited to 5 from the fall to the strike price plus the 2 premium, a total of 7 per share, however far the share falls. If the share rises to 70, they gain 20 on the shares, less the 2 premium, for a net gain of 18.

The cost of protection depends on the strike price chosen and the time until expiry. A strike price closer to the current price gives more protection but costs more.

Protective puts are useful when an investor wants to keep a position but is worried about a short-term fall, such as before an earnings announcement. The premium is a real cost, so buying protection continuously can significantly reduce long-term returns.

Note: A married put is a protective put bought at the same time as the shares. "Protective put" usually refers to a put added to shares already owned. The economic effect is the same.