Volatility Paradox

Overview

The Protective Put is the most intuitive options strategy. It is pure Insurance.

If you own 100 shares of a stock, you are exposed to everything that can go wrong. If the stock gaps down 50% overnight, you lose 50% of your money. By buying a put option, you set a "Floor" price. No matter how bad the market gets, you have the contract right to sell your shares at the strike price.

[!IMPORTANT] A Protective Put is functionally the same as a Long Call. Both allow you to profit from the upside while capping your downside at a fixed amount.

The Setup

A Protective Put consists of:

Long Stock: 100 Shares of the underlying.
Long Put: Buy 1 Put (typically OTM) at Strike $K$ .

Mechanics: The Safety Net

The Crash: The stock falls to zero. You exercise your put and sell your worthless shares for the Strike price. You have "protected" your capital.
The Rally: The stock doubles. Your put expires worthless (you lost the insurance premium), but you still made a massive profit on the shares.
The Insurance Cost: The catch is today's cost. You have to pay cash upfront for the put, which "drags" on your performance if the stock doesn't move.

Payoff and Break-even

Max Profit

Unlimited. You still own the stock, so if it goes to the moon, you go with it.

\text{Max Profit} = \text{Price} - \text{Purchase Price} - \text{Put Premium}

Max Loss

Limited. The worst-case scenario is capped at your put strike.

\text{Max Loss} = (\text{Purchase Price} - \text{Strike}) + \text{Put Premium}

Break-even Point

Higher than your purchase price, because you have to earn back the cost of the insurance.

\text{Break-even} = \text{Purchase Price} + \text{Put Premium}

The "Convex" Greeks

Protective puts change the "shape" of your risk from a straight line to a curve.

1. Delta: Shielded Exposure

While stock has a Delta of 1.00, the protective put reduces your "Net Delta." If the stock falls, the put's Delta becomes more negative, offsetting the stock's positive Delta and bringing your net risk closer to zero.

2. Gamma: The Accelerator

You have positive Gamma. This is a good thing! It means as the stock moves in either direction, your "Net Delta" adjusts in your favor (growing on rallies, shrinking on crashes).

3. Theta: The Insurance Bill

You have negative Theta. Paying for a put is like paying a monthly insurance premium. If nothing happens, that money is gone forever.

When to Use?

Black Swan Protection: Before an election, an earnings report, or a major economic announcement.
Hedging Profits: You've made 50% on a stock and want to "lock in" those gains without selling and triggering taxes.

Checklist for Entry

Is the cost of the put reasonable (check the IV)?
Is the strike price at a level where I'm "okay" with the loss?
Have I considered if a Collar (selling a call to pay for the put) is a better deal?

Synthetics: The 'Mirror' TradeRead more

As mentioned earlier, a Protective Put is synthetically the same as a Long Call.

\text{Stock} + \text{Put} = \text{Call} + \text{Cash}

If you own 100 shares and buy a $100 put, your risk profile is exactly the same as if you just bought a$ 100 call and kept your cash in a savings account. Choosing between the two often comes down to dividend yields and capital requirements.

Protective Put