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The Protective Put Strategy can be adjusted to address the particular lean that the stock owner has at a particular time. (The term lean describes the stock owner’s perception of the directional strength of the stock.)
At any given time, an investor could feel that a stock may go up or down, a little or a lot, or just stay where it is. The protective put is not a position you would put on if you feel that the stock you own was going to consolidate for a while. You would have a loss in the stagnant lean scenario since the stock made no gain but you were out $1.00 for the purchase of the put.
However, the situation is different in a bullish lean scenario.
A stock that has the potential to rise quickly also has the potential to fall just as quickly. A stock that has substantial potential gain has an equal potential loss.
An investor choosing to buy a stock like this should have more protection to the downside then a covered call can provide and at the same time more allowance for a larger upside potential than the covered call allows.
This is a perfect time to use the protective put strategy. The purchase of an out-of-the-money put will be a relatively inexpensive investment but will provide the kind of results that will best fit a bullish lean.
You will have maximum downside protection with all the room you need for your stock’s potential run up. Of course, this comes at a price. You must pay for the protection and freedom this position can provide.
The protective put can also be used when you have a little bearish lean on your stock. Let’s say that you own a stock that has taken a very nice run up. The stock has gotten to a point where you think about possibly selling and taking your profits but are afraid to because you feel it may still run up more and you will not forgive yourself for getting out too early.
Instead of selling the stock and missing out on the continued run, look into buying a put for protection. It will allow you to continue your capital appreciation as the stock trades up while limiting your loss to a fixed, known amount.
In cases such as this one, the purchase of an at-the-money or slightly in-the-money put will ensure you get a good sale price if the stock heads down and allows you ongoing profit if the stock continues up.
Of course, if the stock stays still, you would lose the amount of premium you spent on the put. If the stock goes up, it would have to trade higher than the amount you spent on the put before your long stock’s upward movement starts to make you money again.
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