The Protective Put Strategy
From a premium standpoint, we must keep in mind that by purchasing an option, we are paying out money as opposed to collecting money. This means that our position must “outperform” the amount of money that we put out which is the opposite side of what we did in the covered call strategy.
If we were to pay $1.00 for a put and we owned stock against it, we would need to have the stock increase in price $1.00 just for us to break even. Unlike the covered call, the protective put strategy has the premiums working against it, thus the stock needs to move more to offset the cost of the put.
This is why long option strategies need more volatility than short option strategies. Earlier we talked about the covered call strategy needing to be done over a decent period of time (a year or so) in order to take advantage of the odds.
We stated that selling options and collecting the premium was the right thing to do 75% – 82% of the time. If this is true, then buying an option and paying out premiums is only going to be right 18% – 25% of the time.
Those are not good odds. So, you should try to stay away from employing this strategy over a long period of time to avoid having the odds fall against you. However, employing a protective put can be extremely effective in the proper situation.
Let’s take a look at the risks and rewards of the protective put strategy over three different scenarios.
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