Protective put

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A protective put is a strategy that consists of adding a long put position to a long stock position. The put option acts like an insurance policy-it costs money, which reduces the investor's potential gains from owning the security, but it also reduces the investor's risk of losing money if the security declines in value. If the stock stays strong, the investor still gets the benefit of upside gains. However, if the stock falls below the strike, as originally feared, the investor has the benefit of several choices:

One choice is to exercise the put, which triggers the sale of the stock. The strike price sets the minimum exit price. If the long-term outlook has turned bearish, this could be the most prudent move.

Another alternative is to keep the stock and sell the put. The sale should recoup some of the original premium paid, and may result in a profit. If so, it in effect lowers the stock's cost basis.

If the investor feels uncertain, the put could be held into expiration to extend the protection for as long as possible. Then it either expires worthless or, if it is sufficiently in-the-money, is exercised and the stock is sold. [1]

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  1. Option Strategy: Protective Put. The Options Industry Council.