Protective Puts — Insurance for your stocks How to ... - CommSec

Protective Puts — Insurance for your stocks
Chances are you wouldn’t dream of not insuring your house or car — they’re simply too valuable to risk
losing. The put in a protective put strategy acts as an insurance policy that you can execute at your
discretion to sell your underlying shares at a predetermined price, should the underlying share price fall.
This gives you the right to sell the shares at the strike price of the Put Option, no matter what
happens to the price of the underlying stock.
Market view: Long term bullish, short term bearish.
How to Implement
The strategy involves buying 1 Put Option for every 1000 shares* you own.
Example:
You hold 1000 BHP shares, currently trading at $42. You are concerned about a possible short-term
fall in value, so you buy 1 BHP $41 Put for 0.60 (total cost is $600). Your maximum possible loss is
now: $41 – $42 – $0.60 = $1.60 per share or $1600. At the same time, you will still benefit from any
profits if the price rises.
Protective Put – Payoff Diagram
Profit
Strike Price
$41
Return on strategy
Unlimited Profit
$37 $39 $41 $45 $47
Stock Price
$1.60
Per share
Max loss
Loss
Current Market Price
$42
Break Even Price
$42.60
(Stock price + Option premium)
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Benefits
The benefits of this strategy are:
You retain all capital growth associated with ownership of the stock.
Limit risk – you know the maximum possible downside on the trade.
Peace of mind from price certainty on the trade, regardless of how much the price falls.
You are entitled to all ordinary dividends over the life of the strategy.
Access to all corporate actions that may occur in the stock.
Disadvantages
Purchasing Put Options increases your breakeven price due to the cost of the Option.
If the stock increases in price or remains steady, the Put Option could expire worthless.
This means you may have been financially better not paying the option premium.
Risk vs Reward
Scenario When Result
Best Case The share price rises dramatically. Any dividend income and unlimited
capital gain. Option expires worthless.
Break even
Worst Case
The share price rises by the amount
of the premium paid.
The share price falls below the option
strike price.
Nil profit.
For the cost of the agreed premium,
losses are limited, as you can sell the
stock at the strike price.
* Options contracts may vary in regard to the number of underlying shares.
Important information:
Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (“CommSec”) is a wholly owned, but non-guaranteed, subsidiary of the Commonwealth
Bank of Australia ABN 48 123 123 124 AFSL 234945 (“the Bank”) and a Participant of the ASX Group.
A Product Disclosure Statement for Exchange Traded Options issued by Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (CommSec) is
available from www.commsec.com.au and should be considered before making any decision about the product.
As this information has been prepared without taking into account your objectives, financial situation or needs you should, before acting on this information,
consider its appropriateness for your circumstances, and if necessary seek professional financial and taxation advice. Examples provided are hypothetical for
illustrative purposes only and do not represent a recommendation from CommSec in regard to the strategies, derivatives or securities mentioned.
Trading exchange-traded Options (Options) can involve considerable risk. For that reason, you should only trade Options if you understand the nature of the
product (especially your rights and obligations) and the extent of the risks you are exposed to.
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