In our quest to understand trading options for income, we often consider protecting long stock positions from large downside moves with long Puts. This strategy is called the Protective Put. In this article we will determine if the Protective Put is worth the cost.
Generally a Protective Put is bought during bear markets to bring the delta of the Long stock to zero. For example, if we have 100 shares of stock and the delta of the Put is -25, then we purchase four options to cover the 100 delta of 100 shares.
When purchasing a Protective Put, we consider the following: the strike, and the DTE (days till expiration). Tasty Trade recently tested the value of a Protective Put using the SPY (the S&P 500 ETF). The test period selected was 2007 through 2009, a bear market when the Protective Put would be most effective. The 100 shares of stock selected was the SPY ETF, and Long Puts were purchased monthly the day after expiration at two levels: 2 Puts ATM (at the money), and 4 Puts 70% OTM (out of the money) with deltas of -25. The Long Puts were held to expiration, or approximately 30 days.
The results: without the Protective Put, the value of the SPY stock declined -$3,018 over the 3-year hold period. With the Protective Put, the loss was actually higher: -$3,862 ATM (only 24% were winners; max winner $2,920); -$3,651 70% OTM (16% winners; max winner $4,368).
In conclusion, this test calls into question the value of the Protective Put. Perhaps another strategy to consider would be the Collar; a Protective Put combined with a Covered Call. By selling an OTM Call, a large portion of the cost of the Put is covered, and this would likely improve the P&L. With a Collar, however, if the price of the underlying asset (the Long SPY ETF) rises, the short Call might be assigned forcing the sale of the SPY ETF; if this occurs, then the whole position (including the long Put) should be closed out.
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