4.3.1.1. Protective Put
What we have just described is called a protective put. A protective put is an options strategy in which an investor buys a put option against a product the investor already owns to protect its unrealized gains. Let’s run through an example to see how it works in comparison to a futures contract.
Suppose a farmer is long corn in April and fears a price decline before he can bring his product to market in September. With the current spot price of corn at 260’0 and the September futures contract selling at 300’0, the current basis is 40’0 under September. For simplicity, we will assume that the basis does not change over the course of the next several months.
Table I shows how the farmer will make out in September under a variety of price scenarios if the farmer hedges his risk with futures contracts. Whether the cash and futures prices rise or fall, if the basis remains unchanged, the farmer will receive 260’0 for his corn. If the cash price falls 40 cents, the futures offset will gain 40 cents. If the cash price increases by 40 cents, the futures offset will lose 40 cents.
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Table I. September Corn Futures Hedge |
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September Futures |
Cash Price |
Futures Gain/Loss |
Net Price |
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260’0 |
220’0 |
+40’0 |
260’0 |
|
280’0 |
240’0 |
+20’0 |
260’0 |
|
300’0 |
260’0 |
0 |
260’0 |
|
320’0 |
280’0 |
-20’0 |
260’0 |
|
340’0 |
300’0 |
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