A Protective Put is a hedging strategy where you buy a put option to protect a long position in the underlying. It limits losses if the price unexpectedly falls.
- Ideal for bullish conditions, where there is a risk of price falling.
- Buying a slightly OTM put provides cost-effective protection.
- Limits potential losses on the long position while retaining upside profit potential.
- Risk is limited to the premium paid for the put option.
Example:
- BANKNIFTY trading at 42,000.
- You hold 1 lot of BANKNIFTY Futures (lot size = 25) at 42,000.
- Buy 41,800 Put (OTM) at ₹120 with a near-month expiry.
- Outcome:
- If BANKNIFTY stays above 42,000 at expiry:
- No impact from the put; you profit from the futures.
- If BANKNIFTY falls to 41,700 at expiry:
- Loss on futures = ₹7,500.
- Gain from the put = ₹2,500.
- Net loss = ₹7,500 − ₹2,500 = ₹5,000.
- If BANKNIFTY falls to 41,600 at expiry:
- Loss on futures = ₹10,000.
- Gain from the put = ₹5,000.
- Net loss = ₹10,000 − ₹5,000 = ₹5,000 (limited by the put).
- If BANKNIFTY stays above 42,000 at expiry: