A protective put is a risk-management strategy using options contracts that investors employ to guard against the loss of owning a stock or asset. The hedging strategy involves an investor buying. Find out how a protective collar is a good strategy for getting downside protection that is more cost-effective than merely buying a protective put. A fence is a defensive options strategy. May 04, · Although most investors' primary goal is to earn profits, one constructive way of using options is to protect your stock portfolio from disasters. Here are four strategies to consider: 1.
When the markets start swinging wildly, Options protection strategies, investors often run for safety. A protective collar consists of a put option purchased to hedge the downside risk on a stock, plus a call option written on the stock to finance the put purchase.
Another way to think of a protective collar is as a combination of a covered call plus long put position. The combination of the long put and short call forms a "collar" for the underlying stock that is defined by the strike prices of the put and call options, Options protection strategies.
The "protective" aspect of this strategy arises from the fact that the put position provides downside protection for the stock until the put expires. A protective collar is usually implemented when the investor requires downside protection for the short- to medium-term, but at a lower cost. Since buying protective puts can be an expensive proposition, writing OTM calls can defray the cost of the puts Options protection strategies substantially.
The main drawback of this strategy is that the investor is giving away upside in the stock in exchange for obtaining downside protection. The protective collar works like a charm if the stock declines, but not so well if the stock surges ahead and is "called away," as any additional gain above the call strike price will be lost.
They should be used with caution in a strong bull market, as the odds of stocks being called away and thus capping the upside of a specific stock or portfolio may be quite high.
Let's understand how a protective collar can be constructed for Apple, Inc. You start by writing a covered call on your Apple position. Recall what we said earlier about a collar capping upside in the stock. If you had not implemented the collar, Options protection strategies, your gain on the Apple position would have been:.
A collar can be an effective way to protect the value of your investment at possibly a zero net cost Options protection strategies you. For example, what if you own a stock that has risen significantly since you bought it? Maybe you think it has Options protection strategies upside potential, but you're concerned about the rest of the market pulling it down. One choice is to sell the stock and buy it back when the market stabilizes.
You might even be able to get it for less than its current market value and pocket a few additional bucks. Of course, if you're forced to sell your stock to the call holder or you decide to sell to the put holder, you'll have taxes to pay on the profit. You could possibly help your beneficiaries, too. A protective collar is a good strategy for getting downside protection that is more cost-effective than merely buying a protective put.
The Options protection strategies is that the overall cost of hedging downside risk is cheaper, Options protection strategies, but upside is capped. Advanced Options Trading Concepts. Your Money. Personal Finance.
Your Practice. Popular Courses. Login Newsletters. Here's how the strategy would work out in each of the following Options protection strategies scenarios:.
Your overall gain would be:. Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Partner Links. Related Terms Fence Options Definition A fence is a defensive options strategy that an investor deploys to protect an owned holding from a price decline, Options protection strategies, at the cost of potential profits.
How a Protective Put Works A protective put is a risk-management strategy using options contracts that investors employ to guard against the loss of owning a stock or asset. Collar Definition A collar, commonly known as a hedge wrapper, is an options strategy implemented to protect against large losses, but it also limits large gains.
Define Employee Stock Option ESO An employee stock option is a grant to an employee giving the right to buy a certain number of shares in the company's stock for a set price. Outright Option Definition and Example An outright option is an option that is bought or sold individually, and is not part of a multi-leg options trade.
Learn about the four basic option strategies for beginners. a covered call strategy provides limited downside protection in the form of premium received when selling the call option. Find out how a protective collar is a good strategy for getting downside protection that is more cost-effective than merely buying a protective put. A fence is a defensive options strategy. The put can provide excellent protection against a downturn during the term of the option. The major drawback of the strategy is its cost, which raises the bar on netting upside profits. Investors who aren't very bullish might have better strategy alternatives. Outlook.