Options Trading: The Protective Put Strategy In Different Scenarios
Topics: options trading, options trading strategies, stock options trading, stock trading
As previously stated, when we buy a stock, three potential outcomes exist. The stock can go up, go down, or remain stagnant. Let’s hypothesize results across these three scenarios. Say you buy the stock for $31.00 and buy the front month 30 put for $1.00.
In the ‘up’ scenario, let’s assume the stock price is $31.50 at expiration. The results are that you have a $.50 gain from capital appreciation and a $1.00 loss from the purchase of the put which combined gives us a $.50 overall loss.
It is important to realize that the up scenario will only produce a positive return if the stock gain is greater than the amount paid for the put. That being the case, you calculate the breakeven point for the protective put strategy by adding the purchase price of the stock to the price of the put.
In the ‘up’ scenario, add the stock price $31.00 plus the option price $1.00 and you get a breakeven of $32.00. So, until the stock reaches $32.00, the position will not produce a positive return. Above $32.00 the position will gain the amount equal to the stock price minus the premium paid for the option..
In the ’stagnant’ scenario, the position will produce a loss. Since the stock hasn’t moved, there will be no capital gain or loss and with the stock at $31.00 at expiration, the puts are worthless. The position lost $1.00, the amount you paid for the puts.
In the ‘down’ scenario, the position will again produce a loss. If the stock price were to trade down $1.00 to $30.00, then you would have a $1.00 capital loss.
With the stock at $30.00, the 30 puts will be worthless, thus you incur a $1.00 loss because that is what you paid for them. Your total loss will be $2.00.
However, in the ‘down’ scenario, the protective put will set a cap on your losses. Let’s see how that works. We’ll set the stock price down to $28.00. Since you purchased the stock at $31.00, there will be a capital loss of $3.00.
The puts, however, are now in the money with the stock below $30.00. With the stock at $28.00, the 30 puts are worth $2.00. You paid $1.00 for them so you have a $1.00 profit in the puts.
Combine the put profit ($1.00) with the capital loss (-$3.00) and you have an overall loss of $2.00. The $2.00 loss is the maximum amount you can lose regardless of how low the stock declines, even if it goes as low as zero. This is what is meant by maximum protection.
In every protective put position it is possible to calculate your anticipated maximum loss. Use the formula: (stock price minus strike price) minus the option’s price equals total maximum loss.
Maximum Loss = (Stock Price - Strike Price) - Option Price
For example, suppose you paid $30.00 for your stock. You bought the front month 27.5 put for $1.00. Next, assume the stock closes at $27.50 on expiration day.
Your maximum loss calculation would be:
($30.00 - $ 27.50) - $1.00 = $3.50
$30.00 (stock price) minus 27.5 (strike price) equals a $2.50 capital loss. Do not forget that with the stock at $27.50, the 27.5 puts will be worthless.
Add the capital loss ($2.50) plus the option loss ($1.00). The total is $3.50 which is your maximum possible loss in that position. This formula will work every time.
Looking at the three hypothesized scenarios, we find that only one scenario, the ‘up’ scenario, can produce a positive return and that’s only when the stock increases more than the amount you paid for the puts.
The other two scenarios produced losses. If the stock is stagnant, you lose the amount you paid for the put. If the stock goes down, you lose again- but the loss is limited. It is the limiting of loss that makes the protective put an attractive and useful strategy.
Ron Ianieri is currently Chief Options Strategist at The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk. For more information please contact The Options University at www.optionsuniversity.com or 866-561-8227
Previous Articles Highlighter:
Holiday Insurance - A Price You Cannot Afford To Save (1)
Yes, you have to pay upfront for vacation medical insurance and you may think that the monthly payment obligation is unnecessary. And think about it for a while. If you got into an accident or whatever situation that needs you to be hospitalized and the medical bills are so high, you may not have that money with you right there and then.
What Are Credit-Based Auto Insurance Scores? (2)
Two factors that are commonly used in determining an insurance score are: Past insurance claims and past financial history as it relates to credit and loans. In general terms, this information is used to determine how likely a person may be to have an accident or to file an insurance claim.
Student Loans Will Fund Your College Career (3)
Federal loans are some of the loans you can consolidate, with their own consolidation programs such as FFELP (SLS, PLUS, and Stafford), Health Professional Student Loans, FISL, NSL, Perkins, Direct Loans, Guaranteed Student Loans, and HEAL.
Your Health Insurance Plan - What You Need To Know (4)
It is up to you to choose the right one for you. Any insurance involves a regular monthly payment obligation and these payments will ensure that you can cover at least some of (depending on the plan) the expenses you could incur if ever your health will fail.
Grants! Do I Qualify? (5)
Whether or not you qualify will often depend on where you are based, what business sector you operate in and what you want the money for. What are Grants for?
Student Loans - Consolidation Can Change Your Life, Literally! (6)
There are, however, some conditions to this. The conditions include that when reconsolidating, other loans will be included with the consolidated loan. Another thing is that reconsolidation can only be done once and once only.
Your Dental Health Insurance Plans - What You Need To Know (7)
Also, decay is not the only teeth problem and accidents may happen that could bring about broken teeth. With any dental plan, you will not be burdened down by repair or replacement costs.
Choosing A No Annual Fee Credit Card (8)
Some institutions charge as much as $39 for a late fee, which makes up for them not charging an annual fee. Many institutions also have a policy that the low interest rate is only locked in as long as payments are made before the deadline.
What's The Process For Fixing Mistakes On Your Credit Report? (9)
The next step is one that many people also neglect. They may find errors on their credit report, but they do not take the time to actually notify the credit reporting agencies about those errors.
Do You Know What A Credit Reporting Agency Is? (10)
The people who do all of the updating of your credit reports and credit scores are members of a credit reporting agency. A credit reporting agency is basically another word for credit bureau, which may be a little bit more familiar term to credit users.
First Steps To Understanding The Bankruptcy Code (11)
They don't have the right to change the law, just factors that pertain to their specific state can they add. The states can only provide other laws that are compatible with their state's laws.
Learning The Difference Between Legitimate Loans And Loan Schemes? (12)
Still, there are several out there who claim to be "credit lenders" who are actually just out to get your money and ruin your credit history for you. These kinds of "lenders" are the kind we need to watch out for.
When Is An Installment Loan The Right Choice? (13)
Installment loans are basically what is used to make one big purchase. When you buy something using an installment loan, you are allowed to make only one fixed payment every month, rather than having it change continually.
Do You Even Know What You're Credit Score Is? (14)
When you get a credit card, buy a car using on a loan, or get a student loan, you need to consider how your actions will affect your credit score.
Your Credit Report - Seven Years Later (15)
So let's say you have a few things on your credit report that you are not proud of, but you've learned your lesson and you've moved on. So now that you have better spending and payment habits, you want to get rid of those black marks on your credit report.
How Do You Know If Someone Has Used Your Credit To Obtain A Loan? (16)
Lending agencies may call you to let you know that you got approved for a loan that you did not even apply for. Getting contacted by a loan officer who says you spoke with him or another earlier before applying for a loan is obviously a red flag, and immediate action should be taken.
If You're Upside Down In A Car Loan, How Can You Get Out Of It? (17)
This option can be accomplished by contacting a financial advisor and together organizing a specific plan that works out best for you. Refinancing your multiple auto loans will also assist you in getting a lower interest rate because all of your loans are consolidated into one.
What Do I Do If I Earn Too Much To Qualify For Student Loans? (18)
Staying focused, persistent and educated about emerging opportunities can do this. Court helps people to learn about federal student loans. You can read more of his work by visiting: whalehookloans.com.
How Much Does A Kid Need To Save In Order To Be Ready For College? (19)
The biggest tip to earn money to be able to work with and budget is to work, work, work, during all breaks from school. Save the money you make, and when the school year starts you will know where the monthly money goes with your previous made budget.
Retirees 'Need Finances In Shape Before Heading Abroad' (20)
With this playing on the mind of many UK home owners, who could use a secured loan to fund a holiday abroad or a further property purchase, Barclays suggested that many were looking to escape the dreary UK summer.
Newer Articles Highlighter:
Investing In Energy Funds (1)
And, there's only so much oil (natural gas and coal) in the ground. I'm not suggesting we'll run out but it will become more expensive to extract it. How can you ease the pain every time you fill up?
How To Asses Bankruptcy Petition Cost (2)
You will be happy to know that now there are many options available to you, using which you can file for bankruptcy without spending a fortune. All you need to do is just to keep in mind the following factors.
Will My Credit History Affect My Student Loan Situation? (3)
There exist several scenarios where customers attempt to obtain a loan but the long and complicated process of the whole thing basically scares them off and they are therefore unable to obtain the necessary money that they need.
Save Money On Groceries (4)
2. Community Supported Agriculture, CSA Check out the local CSA in your area. This is where you purchase, in advance, a share of a farmer's harvest. The food is healthy, fresh, and does not travel long distances so it can be ripened on the vine instead of picked early and artificially ripened.
Disputing Errors On Your Credit Report Can Save Your Score (5)
There are several formats you can find on the Internet or through advertisements in the mail that you should follow to get the most professional sounding letter. A dispute letter is the first thing that will get your problems out in front of the credit reporting agencies to see, which they must then investigate once they receive your dispute letter.
Tips On Refinancing Your Car Loan The Right Way (6)
In many cases, however, several car consumers experience troubles in making the payments of a loan and do not have any other way out that is available to them. They basically must pay the monthly installements until the auto loan is eventually paid off sometime in the future.
Can You Improve Your Credit Score By Paying Off Debts In Collections? (7)
The achievement of a very good credit history is essential to the monetary protection and increase of your personal salary and belongings. Looking from a realistic standpoint, several potential financial investors in the world today have become victims to great money troubles and have not be able to achieve a high credit score and therefore suffer under the pressures of serious financial burdens and troubles.
How Do Borrowers With Bad Credit Get Car Loans? (8)
Probably the most common kind of a loan that investors attempt to obtain is a car loan. The procedures of getting a car loan are somewhat easy for prime borrowers, but much more difficult for subprime borrowers.
5 Great Reasons To Buy A Polaris World Property (9)
Key-ready and off-plan properties are available that offer views over the Jack Nicklaus designed golf courses. Villacashback.com specialises exclusively in Polaris World property. To get the latest brochure, DVD and price list, please visit www.villacashback.com
How Do You Know When You're Dealing With A Good Mortgage Lender? (10)
They have great difficulties in knowing what to look for and how to begin a working relationship with a mortgage lender. Several various places are available where you can look in order to find a mortgage lender that will best fit your financial needs and circumstances.
Is It Wiser To Open A Home Equity Line Of Credit Or Get A Second Mortgage? (11)
It is basically another mortgage that is applied for a second time by home owners that already have acquired a first mortgage on their home. Second mortgages work exactly the same as first mortgages in that they require regular payment to be made according to a set schedule that has been determined by the loan contract.
Don't Make These Common Auto Loan Mistakes (12)
You should always try to remember to use certain strategies and techniques that will most effectively help you to acquire an auto loan that fits your needs. Probably one of the most crucial aspects to maintain in remembrance when trying to obtain a car loan is to do all the research that it requires to obtain the most effective loan out there.
Advice On Getting Your Student Loan Interest Rate Reduced (13)
Several students sometimes even obtain several loans to help them earn multiple degrees of higher education at different educational institutions. These multiple loans can greatly help a person's financial situation at the present time, but will bring about some monetary burdens in the future.
If I Don't Pay My Doctor Bills, Will It Hurt My Credit Score? (14)
Unpaid doctor or medical bills, for example, can definitely affect the level of your credit score. Some people ask if medical bills are counted toward a person's credit history, and the answer is a definite yes.
Is There Any Way To Improve Your Credit Without Actually Paying Off Your Judgments? (15)
With these unfortunate circumstances come a number of different consequences that make people fall under the pressures of financial troubles. Probably the most serious circumstance for those with a very bad credit history arrives when the monetary institution has to begin repossessing the customer's belongings so that it enables them to pay for the loan that was taken out.
What's The Better Choice - Take A Bigger Loan Or Make A Bigger Down Payment? (16)
This decision is very crucial to your financial security and should be looked at and discussed with a professional financial advisor who knows how to best handle your specific situation.
Want To Get A Mortgage? You Need To Improve Your Credit (17)
The other method that will ultimately increase your credit history is to establish a positive money relation with the credit card companies. Making your credit card payments on time is the first step, but by also consistently making big payments on your credit cards, companies will be more than happy to give you money in the form of a mortgage.
A Simple Online Forex Trading Guide (18)
These account service managers may be reached via email, phone, or other forms of online communication. These online trading platforms also offer demonstrations that can simulate real time trading situations in the Forex market.
Mortgage Refinancing Scams - Dangerous Waters (19)
Mortgage refinancing scams will take advantage of different situations and will make you get to a point where loosing your home is a reality you can not stop. There have been many individuals hit by mortgage refinancing scams.
A Guide To Desiphering Forex Quotes (20)
Quick fact : The Forex market is by far the largest financial market in the world, and includes trading between large banks,central banks, currency speculators,multinational corporations, governments, and other financial markets and institutions.
Permalink to Options Trading: The Protective Put Strategy In Different Scenarios