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. Now suppose the farmer buys at the money puts with a strike price of 260’0 and a premium of 15’0. Whether prices rise or fall, the protective put never costs the farmer more than 15 cents per bushel ($750 per 5,000 barrels). No matter how far the September price may fall, the protective put will limit the farmer’s losses to the amount of the premium. A put also allows the farmer to still benefit from rising corn prices. No matter how high corn prices rise, the farmer will reap a profit from those rising prices, deducting only the cost of the premium from those profits.
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Table I. September Corn Protective Put |
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Protective Put |
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|
Put Strike Price |
Cash Price |
Premium |
Gain/Loss |
Net Price of Corn |
|
260’0 |
220’0 |
-15’0 |
-15’0 |
245’0 |
|
260’0 |
240’0 |
-15’0 |
-15’0 |
245’0 |
|
260’0 |
260’0 |
-15’0 |
-15’0 |
245’0 |
|
260’0 |
280’0 |
-15’0 |
+5†| |