Investing Assets & Markets Options What Is a Protective Put Option? Protective Puts Explained in Less Than 5 Minutes By TJ Porter Updated on June 28, 2022 Reviewed by Michael J Boyle Reviewed by Michael J Boyle Michael Boyle is an experienced financial professional with more than 10 years working with financial planning, derivatives, equities, fixed income, project management, and analytics. learn about our financial review board Fact checked by Mrinalini Krishna In This Article View All In This Article Definition of Protective Put How Does a Protective Put Work? Pros and Cons Meaning for Individual Investors Photo: Tashi-Delek / Getty Images Definition A protective put is an options strategy that reduces the potential risk of owning a stock. A protective put is an options strategy that reduces the potential risk of owning a stock. Investors who own shares in a company can buy puts, giving them the right to sell those shares at a specified price. Protective puts involve buying puts with a strike price below the current market value of the stock to limit their losses. This article discusses protective puts, how they work, and whether they’re a good idea for investors. Definition and Examples of a Protective Put A protective put is a type of a put option strategy that helps investors limit their maximum losses from owning a stock. This strategy is often employed by investors who are bullish on a long-term price rise for a stock but bearish over the short term. Alternate name: Married Put When you own a stock, you can earn a profit if that stock gains value. You can lose money if the stock’s price falls. Your maximum loss is equal to the value of a share, multiplied by the number of shares you own. For example, if you own 100 shares of XYZ, each worth $25, you have $2,500 invested. If XYZ becomes worthless, you could lose $2,500. Note Put options give the holder of the option the right, but not the obligation, to sell shares to the option seller at a set price, called the strike price. Continuing the above example, you’ll be employing a protective put if you buy a put option on XYZ with a strike price of $20 in addition to the shares you own. With this put option, you can sell your shares to the option seller for $20 each, no matter what their market value is. You do have to pay a premium when you buy an option, so that also factors in your profit or loss calculations. This premium is typically higher the closer the strike price is to the stock’s current market value and the more time there is between the current date and when the option expires. They’ll also tend to be higher for more volatile securities. How Does a Protective Put Work? You can think of protective puts as being like insurance. You pay a premium to buy a put with a strike price below the current value of a stock you own. In exchange, you limit your maximum loss on the stock to the difference between the stock’s current value and the strike price listed in the put. Note A protective put sets a minimum price at which you can sell shares, limiting your potential losses. Let’s illustrate that by continuing with the example of XYZ. You have 100 shares of XYZ that you bought at $25 per share. You also have a put on XYZ with the strike price of $20 for which suppose you paid $2 as the option premium. So your break-even point is $20 - $2 = $18 Now, if the price of XYZ shares begins falling, you can limit your loss by exercising your put option and selling shares of XYZ at $20 a share. Suppose the price of XYZ falls to $10 per share. Your loss per share on the XYZ shares you bought would be $10 - $25 = -$15. Your gain by exercising your put and selling XYZ shares at $20 would be $20 - $10 = $10. Your total net per share is: Loss on stock price + Gain on put exercise - options premium = -$15+ $10 -$2 = -$7 Using the numbers above, your maximum loss would equal ($7) * 100 = $700, which is a much smaller loss than the $1,500 (-$15 * 100) maximum loss without the put. At the same time, you are under no obligation to exercise the put, meaning you can choose to let it expire, losing only the premium you paid. This means that if the price of the stock you’re holding rises, you won’t limit your potential profit. Pros and Cons of a Protective Put Pros Limit your potential lossesNo effect on potential gains Cons You have to pay a premium for the optionRegularly buying protective puts can create drag on your returns Pros Explained Limit your potential losses: With protective puts, there is a minimum price you can sell your shares at, limiting how much you can lose from owning a stock.No effect on potential gains: Because you’re not obligated to exercise a put, it won’t impact your potential gains if the price of the stock rises significantly. Cons Explained You have to pay a premium for the option: Each time you buy a put, you pay a premium, which means you have to pay for the protection.Regularly buying protective puts can create drag on your returns: If you buy protective puts on a regular basis, you could wind up spending significant amounts on premiums. Over the long term, this could reduce your overall returns, especially if you pay high premiums. What It Means for Individual Investors Protective puts are an option for investors who want to own a stock, but who are worried about a significant downturn in its price. You can use them if you want to invest in a security but can’t afford to experience a catastrophic loss. Alternatively, you can rebalance your portfolio to reduce investment risk, such as by increasing your bond holding compared to stock holdings. For long-term buy-and-hold investors, protective puts won’t be particularly useful as they’re more effective for limiting losses in the short term. If you’re investing for something like retirement, protective puts probably won’t be a useful strategy for you. Key Takeaways Protective puts limit potential losses from owning stocks.Protective puts don’t impact maximum gains from owning stocks.Like other types of insurance, you have to pay a premium to buy protective puts.Over the long term, buying protective puts can drag down your investment returns. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Fidelity. "Protective Put (Long Stock + Long Put)."