THE PROTECTIVE PUT STRATEGY
The protective put strategy is an excellent stock option strategy for investors who are primarily ‘stock investors’ as it allows one to accumulate great amounts of stock over time, yet limits the risk of loss. The protective put strategy is also known as the married put strategy.
The major downside of the protective put strategy is that it is ‘capital-intensive’, as one is purchasing both stocks and options. Hence, it is a strategy that is mainly employed by folks who have a substantial amount of money to invest in the stock market. However, it can also be used by the ‘small investor’ with lower priced stock.
When to employ the protective put strategy
- Use the protective put strategy when you wish to make a major capital investment in a stock with ‘good’ fundamentals (earnings potential, earnings growth, dividend distributions, dividend growth, etc), but are concerned about the downside risk.
- Consider the protective put strategy when investing in a stock that has made a strong move up and you wish to ‘lock in your profits’.
- Consider the protective put strategy for highly volatile stocks that are range-bound, but have a bullish bias.
- Consider the protective put strategy anytime you would consider buying a call option (the protective put strategy has the same risk profile as that of a call option, and is in effect a ‘synthetic call’).
How to employ the protective put
- Buy one put for each 100 shares of stock purchased.
- Buy the ATM (at-the-money) or one strike OTM (out-of-the-money) put
- For an initial purchase, buy both the stock and the put in one order (this gives the best prices)
- To ‘protect’ stock that you already own, simply buy one ATM or OTM put for each 100 shares of stock that you own.
- For best results with a stock in a strong uptrend, use the ‘rolling protective put’ strategy’.
The ‘Rolling Protective Put’ Strategy a.k.a. ‘Rolling Married Put’
- Find an optionable stock in strong uptrend
- Buy buy one ATM (or near OTM) put for each 100 shares of stock purchased. (If your broker does not allow you to buy both stock and put in one order, you should consider switching to a broker that does).
- Once the order is executed, your portfolio will contain both shares of stock and puts
- Place a GTC limit order to ‘roll’ up the puts to the next strike up, and let the magic of market volatility do the rest. For more details on how to do this, see ‘How to Trade Stock Options Online’.
- For the ‘rolling protective put’ strategy, I look for the next strike up that will allow me to ‘lock in’ any profit that may come from a transient intraday move in the stock price, and allow me to offset the cost of the put purchased to protect the stock (and any risk if I bought the near OTM put).
- For either protective put strategy, if the stock breaks to the downside instead of the upside, decide whether your long term prognosis for the stock has changed and whether you expect the stock to plummet or the company to go bankrupt.
- If your long-term outlook for the stock is now bearish, the better part of valor is to accept the loss, albeit a small one, and be thankful that you had a put protecting your investment.
- If your outlook for the stock remains good and you expect the move to the downside is likely to be transient, you can ‘roll’ the put down, and use the money received from the sale of the now ITM put to buy a new ATM/near OTM put as well as more shares of the stock (with their own puts). When the stock recovers, you will have more shares of stock (and puts to ‘roll up’), and, hence, have a larger portfolio.
For more details of the protective put strategy, check out the RandomWalk Trading book “Stocks, Options, and Collars”.