Investments, tenth edition

   Protective Put 

 Imagine you would like to invest in a stock, but you are unwilling to bear potential losses 

beyond some given level. Investing in the stock alone seems risky to you because in prin-

ciple you could lose all the money you invest. You might consider instead investing in 

stock and purchasing a put option on the stock.  Table 20.1  shows the total value of your 

portfolio at option expiration: Whatever happens to the stock price, you are guaranteed a 

payoff at least equal to the put option’s exercise price because the put gives you the right to 

sell your shares for that price.   

    20.3 

Option Strategies 

  Figure  20.6  illustrates the payoff and profit to this    protective  put     strategy.  The 

solid line in  Figure  20.6, panel C  is the total payoff. The dashed line is displaced 

downward by the cost of establishing the position,  S  

0

   1   P.  Notice that potential losses 

are limited.  

 It is instructive to compare the profit on the protective put strategy with that of the 

stock investment. For simplicity, consider an at-the-money protective put, so that  X   5   S  

0

 . 

 Suppose the strike price is  X   5  $100 and the stock is selling at $97 at option expiration. 

Then the value of your total portfolio is $100. The stock is worth $97 and the value of 

the expiring put option is   

X 2 S

T

 5 $100 2 $97 5 $3  

 Another way to look at it is that you are holding the stock and a put contract giving you 

the right to sell the stock for $100. The right to sell locks in a minimum portfolio value 

of $100. On the other hand, if the stock price is above $100, say, $104, then the right 

to sell a share at $100 is worthless. You allow the put to expire unexercised, ending up 

with a share of stock worth  S  

 T 

   5  $104. 

 Example  20.3 

Protective Put 

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  Options, Futures, and Other Derivatives