Protective Put: How to protect your stock's unrealized profits

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In this video, you would learn about the protective put strategy and how you can use it to protect your stock’s unrealized profits by using a real life example of MGL.

Protective Put Options Strategy:

Protective put is an options strategy of using the put option to buy protection against any fall in the price of an underlying that one is holding. It is similar to buying an insurance policy for any asset that an investor owns.

A protective put can either be applied at the same time you initiate a long position in an underlying or to an underlying after the underlying has moved higher or lower.

For the purposes of this video, let us limit our discussion to using the protective put strategy to protect your stock’s unrealized profits once it moved higher.

Let’s learn how to do this by considering a real life example of a stock position of a frequent visitor to our channel - Mr Vivek R.

On June 5th, 2020, Mr Vivek entered a long position in MGL by purchasing 600 shares of the stock at ₹1027 and on June 9th, 2020, as the stock moved down he sold a 25 Jun 1080 strike price Call option at ₹29 to provide some downside protection.

The stock has now moved higher to ₹1074.2 (closing price as of June 12th, 2020) and the sold Call is trading at 48. So, he is currently sitting on an unrealised profit of about ₹16920 and he wishes to protect the gain in the stock price by initiating a protective put.

Let’s look at a few choices he has:

Scenario 1: No Protective Put:

Maximum profit at expiry = ([Call strike price - price paid for the stock] + call premium) x lot size = [1080 - 1027 + 29] x 600 = ₹49200
Break even point = Price paid for the stock - call premium = 1027 - 29 = 998

The maximum profit that can be achieved at expiry is the highest in this scenario but there is no downside protection. A big drop in the stock price can result in some significant losses.

Scenario 2: ATM Protective Put (1080 PE @ 51) Go with this if you expect the stock to stay the same. This is as good as exiting the trade right away.

Maximum profit at expiry = ₹18600

Scenario 3: ITM Protective Put (1100 PE @ 64) Go with this if you expect the stock to move lower.

Maximum profit at expiry = ₹22800
Minimum profit at expiry = ₹10800

Scenario 4: OTM Protective Put (1060 PE @ 40.05) Go with this if you expect the stock to move higher.

Maximum profit at expiry = ₹25170
Minimum profit at expiry = ₹13170

I would recommend the out of the money protective put to Mr Vivek as he is expecting the stock to move to 1100 levels. Also, instead of going with a 25th June Put I would recommend him to go with a 30th July Put as though it would be expensive the time decay would be far less. What according to you should be the best approach? Please mention your choice in the comments section.