Protective Put (Married Put)
The advantage of trading in Future and Options over Cash is that Future and Options provide more choices using which a trader can build multiple strategies. With Future and Options one can also have more armour with them to safeguard themselves from the market. One such utility or strategy is Protective Put. Protective Put can be bought at any time - bought together with the long position or until the time long is held, can be used to protect - partial or complete holding. Married Put, is the strategy when entire sum of the long stock held is protected with a put.
Protective Put is like an insurance for a trader who is long in the market but wants to safeguard himself from any unexpected pullback in the price of his holding by paying a small amount called option Premium. As you may know, Options give buyers a right but do not put any obligations to buy/sell the underlying asset on the expiry date. Option buyer may or may not exercise his option by the expiry date. This is in contrast with Futures where the buyer has the contractual agreement for settlement in either cash or physical delivery of underlying assets at the pre-agreed price and on the agreed date.
Let us understand the concept of protective put with couple of examples and its use cases that can be applied to safeguard your capital and even your profit up to some extent.
Scenario 1:
You pick a stock as below in which you found a good support at around the price 192, the stock seems to bounce back from around that price. You decide to be long on the stock from this price.
However, you may have some apprehensions that the price could go down much below your risk level. As an award-to-risk ratio, you are willing to hold upto 190 but not below. You can buy a put option by paying a premium amount in order to set a limit to your losses. For ease of calculation in the above example, let us assume that you were lucky to buy at price of 190 (Buy Price) to be long on the stock. If you want to play very safe and restrict your losses, you may buy a put option at the same Strike Price of 190 and of the same lot size as your long position. The put option will safeguard your entire capital with maximum loss of price you pay for the premium.
In the above image, your strike price could be 190. Let us assume that the brokerage other fees was Rs. 5 and premium paid for the put option was Rs. 10. So your profit starts from 190+5 and it could be unlimited as long as you hold the stock and its price increases. While you have restricted your loss at 10+5 no matter how far the underling stock price fall.
Given that Options give you right but no obligation to exercise it before or up to the expiry date, you will exercise your put option only when the price falls and limit your losses. While the price increases, you will simply forget about the put option and willingly forgo the premium amount paid.
Scenario 2:
The premium one pays to buy an option is dependent on various factors like strike price, how far is the expiry date from the date of purchase, whether its In/Out/At the Money etc. As explained in the blog by StoxFactor you can find the premium to be paid for buying an option at NSE website.
As you can see from the image, there are different values for LTP (Last Traded Price/Premium) for both Put and Call options at each Strike Price. One can also buy a put for a strike price lower than the purchase price, like in our above example, you can buy a put for 180 strike price. This means that you are willing to risk 190-180 = Rs 10 on your trade. The premium you paid for the Out of the Money put might be lower (lets assume 7) than the one you paid for At the Money. By doing this you have limited your loss at Rs 180. If the lot size of your purchase is 1000, your total loss will be (10+7+5)*1000.
Scenario 3:
Since one can buy a put any time and not necessarily at the same time when one builds a long position. You can buy a protective put at a later stage as long as you hold the long position, e.g. to safeguard your profit.
Let us assume, you bought a stock at 150 and it went to 200 but from there you are unsure if the price will fall back or move above 200 as it has some resistance level. However, you want to safeguard your profit made so far. In this case, you can buy a Put option at Strike Price of 200 by paying a premium (say 5). So in case the price falls below (200-5), you can exercise your option and still book your profit at 195 * lot size. If the price moves above 200 you will forgo the premium amount and happily add on the profits.
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