What is a protective put?Buying a protective put can be a great way to help cut your losses short in the stock market. This is a strategy that many big name investors use in order to protect themselves from the downside when the markets get choppy. So what is a protective put? When you buy a put what you are doing is buying the right to sell a given stock at a given level on or before expiration. This is true no matter how low the stock price is. So think of it like insurance on stocks. You own a stock trading at $107. The market has been acting very crazy and you are scared that your stock might crash. So you buy the $100 puts for $3. You paid $3 for the security of being able to sell the stock at $100 if the stock crashes. This is similar to buying insurance on a house. You can buy insurance on a house and if it burns down you can get compensation for it.Now no matter where the stock goes for as long as you own the put you can sell it for $100. That means the most you can lose is $7 + $3 or $10. This is true even if the stock is only worth $2 by expiration. The most you can gain if the stock goes up is unlimited because you do not have to sell the stock if it goes up. You can either let the put expire worthless or you can sell it back to the market and pick up a small loss. Another think I would like to add is that this strategy only gives you the right to sell the stock. If the stock is trading at $99 by the time the option expires and for whatever reason you do not want to sell it you can choose not to. This strategy takes into consideration that protecting your capitol is by far the most important part of trading in the stock market. Without capitol there is nothing to trade with.
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