Protective Put consists of two positions at the same time. One is Long position on the underlying asset (suppose we bought an asset at S0 = USD 120) and buy a Put option (suppose at X= USD 100). Here strike price of the Put option should be lower than the buying price of the underlying asset.
Premium received for selling the call option = USD 10
Maximum loss is fixed from this derivative instrument. Maximum loss = Buying Stock price – X + Premium paid = USD (120-100+10) = USD 30. For any share price lower than USD 100, maximum loss remains same.
There is no upside limit for profit which increases with the increase of share price.
Breakeven price is the share price where the profit stood at 0 and it separates profit from loss. Here the breakeven price would be USD (120+5) = USD 125. For any share price lower than USD 125, the trader will make loss and for any share price higher than USD 125, the trader will gain profit.
The following table shows the profit/loss scenarios for different share prices.
The below chart shows the profit/loss for protective put option with the movement of the share price.
Here we have three graphs
Protective Put trading strategy is used to protect the investment from steep losses due to sudden market correction as the maximum loss is same for any downward movement of the share price. Protective Puts are ideal for investors whom are very risk averse, i.e. they hold stock and are concerned about a stock market correction.