Do you wonder what strategy could be considered insurance for an investment in a portfolio of stocks? There is only one strategy that can be considered insurance for an investment, and that strategy is the Protective Put Strategy.
In the world of investments, there are several strategies that you can study and apply. Some of them have a higher risk of failing but also have a high return if appropriately managed.
Although the rate of return is high, there is no guarantee of having profits all the time. They created the protective put strategy to cope up with this. This article will tackle the protective put strategy considered as one of the common strategies in investments. We will talk about its aspects and nature. If you want to learn this strategy, feel free to read the following information presented in the article.
What Is Protective Put Strategy?
In this section of the article, we will discover the best solution to “What strategy could be considered insurance for an investment in a portfolio of stocks?”. As previously said, the defensive put technique is the answer to that concern. Therefore, the following sections will go over this method.
Protective put strategy is a risk-management strategy that lets the investors use contract options to guard themselves against the loss of having stocks or assets. This type of strategy acts as an insurance policy to minimize the drawback of declining the price of the assets in the future.
Aside from stocks, you can apply the protective put strategy on commodities, indexes, and currencies to protect them from drawbacks. This strategy is used by investors that don’t want to regret the loss of their assets. This investor is usually bullish on their stocks or assets.
Nature Of Protective Put Strategy And How It Works
After learning the meaning of the protective put strategy, we will now discover its nature and its operation. This section will talk about how this kind of strategy works for the advantage of the investors. Typically, investors buy stocks and assets with the hopes of an increase in the value of the bought stocks and assets. Therefore, they usually intend to hold those stocks in their portfolios. However, like stocks, the price of the bought stocks will decline.
With the decline of the prices, the investors must prevent the worst scenario of having a loss in the investment.
This part is where the protective put strategy comes in. This strategy suggests purchasing a put option, called protective put, that sets a minimum value that doesn’t permit the additional loss for the investors. The use of put options is essential in applying this kind of strategy. Put options act as a contract that allows the owner to sell a certain amount of the underlying securities at a predetermined price before or on a specific date.
Put options give freedom to investors to sell their stocks and assets at a price. However, this is only available before the expiration date. With this condition, the investors can decide to have their stocks longer or sell them to prevent additional losses.
To avail of the use of a put option, you have to pay for the fee called the premium. The put option is not free. The price of a put option varies in several factors, such as the underlying asset’s current price, the time until the expiration date, and the implied volatility of the stocks or assets.
Advantages Of Protective Put Strategy
This section of the article will discuss the several advantages of the tackled strategy earlier. This section will help you to evaluate the potential of the protective put strategy.
#1. Limiting the loss and drawbacks
As mentioned earlier, the strategy is helpful to limit the losses and drawbacks from the decline of the stock price. Like an insurance policy, this will guarantee the investors to bounce back from the price drops and damages on the assets.
#2. Allows the potential gain of the stocks
If the investors are still bullish on the stocks, the protective put strategy can allow the investors to have a long position and wait for the potential gain of the assets. Sometimes, you have to wait to gain profit on stocks, and the strategy mentioned can help to preserve long-time assets and ensure the gain of the investors.
Disadvantages Of Protective Put Strategy
If there are advantages, there are also disadvantages to applying this strategy. Therefore, this part of the article will discuss the disadvantages of the strategy discussed.
#1. Potential misuse of premium fee
As discussed earlier, the fee to purchase put option is called the premium. This fee comes from the investors, and this purchase could be useless in some cases. For example, if the stock price continuously rises until the expiration date of the put option, then the purchase of the put option is useless.
#2. Potential additional loss
If you are new in using this strategy and your timing in purchasing put options is very bad, this strategy can cause an additional loss on your stocks and assets. The timing of buying the put option is essential to ensure the gain from buying it. If the stock price suddenly drops and you purchase a put option at that time, it can cause you an additional loss.
This article must have provided you with the perfect solution to your query after this post, “What strategy could be considered insurance for an investment in a portfolio of stocks?”. May the information presented helped you in your endeavor. It is really valued that you took the time and energy to read this post.
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