The main difference between a Protective Put and a Covered Call is that a Protective Put is a strategy where an investor buys put options to guard against potential losses in their stock holdings, while a Covered Call involves selling call options on owned stocks for additional income.
Content:
- What Is Protective Put?
- What Is A Covered Call?
- Covered Call Vs Protective Put
- Difference Between Protective Put And Covered Call – Quick Summary
- Protective Put Vs Covered Call – FAQs
What Is Protective Put?
A Protective Put is an investment strategy wherein an investor purchases put options for stocks they already own. This approach acts as an insurance policy, hedging against potential declines in the stock’s value, providing a safety net without selling the actual shares.
By buying a put option, the investor secures the right to sell their shares at a predetermined price, known as the strike price, within a specified period. If the stock price falls below this strike price, the investor can exercise the option, limiting their losses.
This method is particularly useful in volatile markets. It allows investors to participate in potential upside gains while protecting against downside risks. However, the cost of the put option, which is a premium, reduces the overall profitability of the investment, making it a trade-off between security and return.
For example: Suppose an investor owns shares worth ₹100 each and fears a price drop. They buy a protective put option at a ₹95 strike price for ₹5. If the stock falls below ₹95, their loss is limited to ₹5.
What Is A Covered Call?
A Covered Call is an options trading strategy where an investor holds a long position in an asset and sells (writes) call options on that same asset to generate income. This approach is typically employed when an investor expects moderate growth or stability in the asset’s price.
In executing a Covered Call, the investor sells call options for shares they already own. If the stock price stays below the call option’s strike price at expiration, the option expires worthless, and the investor retains the premium received from selling the call as income.
However, if the stock’s price exceeds the strike price, the investor may have to sell the shares at the strike price, potentially missing out on higher profits. This strategy, therefore, caps the upside potential in exchange for immediate income and some downside protection.
For example: Imagine an investor owns 100 shares priced at ₹100 each. They sell a call option with a ₹105 strike price for ₹3 per share. If the stock stays below ₹105, they keep the ₹300 (₹3 x 100 shares) premium.
Covered Call Vs Protective Put
The main difference between a Protective Put and a Covered Call is that a Protective Put involves buying put options to hedge against potential stock declines, while a Covered Call entails selling call options on owned stock for income, limiting upside potential but providing immediate returns.
| Aspect | Protective Put | Covered Call |
| Primary Objective | To protect against a decline in stock value | To generate income from owned stocks |
| Strategy | Buying put options for stocks already owned | Selling call options on stocks already owned |
| Investor Expectation | Anticipates potential stock price decrease | Expect moderate growth or stability in stock price |
| Risk Mitigation | Limits potential losses | Provides some downside protection |
| Profit Potential | Profits are limited by the cost of put options | Capped at the strike price of the sold call options |
| Suitable Market Condition | Volatile or uncertain markets | Stable or moderately bullish markets |
Difference Between Protective Put And Covered Call – Quick Summary
- The main difference between a Protective Put and a Covered Call is that the former is for hedging against stock declines by buying put options, while the latter involves selling call options for income, capping potential gains.
- A Protective Put is a strategy where investors buy put options for their stocks, serving as insurance against value declines. It hedges risks without requiring the sale of the underlying shares.
- A Covered Call, an income-generating strategy, involves selling call options on an asset the investor owns, ideal for expecting moderate growth or stability in the asset’s price.
Protective Put Vs Covered Call – FAQs
What Is The Difference Between Protective Put And Covered Call?
The main difference is that Protective Puts provide downside protection for owned stocks, suitable for volatile markets, while Covered Calls generate income by selling call options, ideal for stable or moderately growing markets.
What is a protective put example?
An example of a protective put: An investor owns shares worth ₹100 each and fears a decline. They buy a put option at a ₹95 strike price for ₹5, limiting potential loss to ₹5 per share.
When should you use a protective put?
Use a protective put when holding stocks you believe may face short-term downside risk, but you want to retain for potential long-term gains. It’s ideal for hedging against market volatility and uncertain events.
What is a covered put?
A covered put is an options strategy where an investor short-sells a stock and simultaneously sells a put option on the same stock, aiming to profit from a decline in the stock’s price.
When should you use a protective put?
Use a protective put when you wish to hedge against potential short-term losses in your stock holdings, while maintaining the opportunity for long-term gains, especially during periods of market uncertainty or expected volatility.
Can I sell a covered put?
Yes, you can sell a covered put. In this strategy, you short-sell a stock and sell a put option on it, aiming to profit if the stock price declines or stays the same.
Is the covered put bullish or bearish?
A covered put is a bearish strategy. It involves short-selling a stock and selling a put option on it, indicating the investor’s expectation that the stock price will decline or remain stable.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, commodity and hence we bring you the important topics and areas that you should know:
