Protective Put and Its Equivalent Call Option Position

A protective put is an options strategy used to hedge against potential losses in a stock position. It involves buying a put option for a stock you already own. This strategy ensures that if the stock price falls below the strike price of the put option, the losses from the stock position are offset by the gains from the put option. Essentially, the protective put acts as insurance against downside risk.

In terms of call options, a position that is equivalent to a protective put is known as a covered call. A covered call involves holding a long position in a stock and selling a call option on that same stock. This strategy provides a limited form of downside protection because the premium received from selling the call option helps offset losses in the stock position. However, unlike the protective put, a covered call does not provide complete protection against a significant decline in the stock's value.

Here's a comparison of the two strategies:

Protective Put

• Purpose: Hedging against downside risk in a stock position.
• Components: Long stock position + Long put option.
• Benefit: Provides insurance against a drop in stock price; maximum loss is limited to the difference between the stock price and the strike price of the put option, plus the premium paid for the put.
• Cost: Premium paid for the put option.
• Risk: Limited to the premium paid for the put option.

Covered Call

• Purpose: Generating income from premiums and providing some downside protection.
• Components: Long stock position + Short call option.
• Benefit: Premium received from selling the call option provides a cushion against losses.
• Cost: None; instead, you receive a premium for selling the call.
• Risk: Limited downside protection; potential losses if the stock falls significantly, but premium income can offset some of these losses.

Both strategies offer different types of protection and are used based on the investor's risk tolerance and market outlook. While the protective put offers more direct insurance against declines in stock prices, the covered call provides an opportunity to earn income while also offering some downside cushion.