If the idea of investing your hard earned dollars into potentially risky, but then again, potentially profitable investment options, there may be a solution which will help to put your mind at ease.
A commonly used risk-management strategy for investors who are a little unsure about whether or not their investment will definitely be a profitable one, but at the same time, don’t want to risk losing out on the potentially sizable gain that could come from a worthy investment venture, can opt to have the investment backed by what is known as a protective put.
A protective put is almost like having an insurance policy on your investment as it provides some level of protection and guards against the loss of unrealized gains.
An investment put must be purchased ahead of time so it does cut down on the amount of profit that an investor would make from a profitable gain, however it also cuts down on the loss should the investment turn out to not be profitable. Protective puts are also sometimes called married puts.
The way that the protective put works is quite simple and it can be understood as a combination of two separate investment positions. Firstly, the investor needs to be owner of the stock in question.
Secondly, the investor must then purchase a put option for that specific stock in the same way that you might purchase an insurance policy on a vehicle, for instance. If the stock goes down in price, the put option will go up in price which will reduce your losses.
The catch though, is that an order to purchase the put option, the investor must pay the premium up front.
Warrior Trading Pro Tip
An investor should be aware of the fact that protective puts are ideally purchased when there is an upward momentum with stock prices.
It is at these times that investors are less likely to be thinking about protecting their stocks so the protective puts can usually be purchased cheaply.
If a stock value ends up dropping, the investor with the protective put option in place will not experience a total loss and the price paid for the premium will have been worth it.
If however, the investment turns out to be profitable, the investor will also profit and the protective put will not need to be employed any further and can simply be left to expire.