Protective put

Owning the underlying and buying a put on it, so losses below the exercise price are covered. Insurance, with the premium as its cost, paid whatever happens.

Where you will meet it

Protective put appears in 5 learning outcomes on the CFA syllabus. A few of them:

• Set out the payoffs from a covered call and a protective put
  CFA Level I · Derivatives

  “A protective put pairs a long position in the underlying with a long put: the downside is capped at the exercise price less the premium, while the upside is reduced by the premium but otherwise intact.”

• Explain a protective put: the objective it serves, how it is constructed, its expiry payoff and value, its profit and risks, the most it can gain or lose, and the underlying price at which it breaks even
  CFA Level III · Derivatives and Risk Management

  “A protective put is a long asset plus a long put, bought as insurance: the holder keeps the upside but sets a floor under value.”

• Contrast the deltas of a covered call and a protective put with that of an asset held long and hedged by a short forward
  CFA Level III · Derivatives and Risk Management

  “A protective put has delta 1 + Δp, with Δp between −1 and 0, so Δp = −0.3 gives 0.7.”

• Interpret the volatility smile and skew
  CFA Level III · Derivatives and Risk Management

  “A steep skew makes protective puts expensive, so a manager might part-fund protection by writing a lower-strike put, or use a risk reversal if expecting the skew to flatten.”

See also

Exercise price

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
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