What is a protective put?

11 July 2025 by National Bank Direct Brokerage
Woman analyzing financial charts on a laptop and a tablet

It is no surprise that even experienced self-directed investors often feel a bit intimidated by options. Yet, many option strategies aren't as complicated as you might think. In fact, a protective put is one option strategy that is straightforward to put in place and execute. Protective puts can be used with all types of investment accounts and can be a way to benefit when the value of a security you own is going down. Find out more about protective puts in this article - what they are and how to use them as part of an investment strategy and investment toolkit.

Many investors may be looking to hold onto a stock over the long term but want to protect themselves from short-term declines in the stock's value. In investment lingo: they remain bullish on the long-term growth potential of the stock but want protection from downside risks.

For some, the solution might be to wait out the stock price downturn, do nothing, and be patient.  For others, it might be tempting to try to time the market. A third possibility is a protective put, a type of options strategy that an investor can apply to protect or hedge against the risk that a stock they own will go down in value. 

Problems with timing the market

One approach to dealing with a downturn in the value of a stock or ETF is to wait it out. Investors with a long-term investment horizon and a higher risk tolerance can simply sit back and hope the stock will return to earlier levels and continue to perform.

Others may elect to time the market.  This means they choose to sell their stock and buy it back later at a lower price. If their hunch is correct, they can buy back the lower priced shares and pocket the difference or buy more shares.

This strategy does have a downside when held in a taxable account, the investor is on the hook for capital gains when they sell the stock. If the difference between the initial purchase price and the higher sale price is large, the tax on the capital gain can be sizable. 

Additionally, if the investor gets the timing wrong and the stock price increases in value after they've sold the holdings, not only will they have missed out on those gains, but buying back the stock will now cost them more money.

Between sitting tight through a price decline or timing the market, a protective put is another strategy investors can use to mitigate against downside risk. It lets an investor hedge against a share or ETF price decrease.

What is a protective put?

Unlike timing the market, buying a put option contract doesn't involve selling the underlying shares immediately. Consequently, if the investor is wrong about the decrease and the share price increases or remains the same and expires out of the money, they will lose the premium they paid on the put option contract but still could benefit from the uptick in value since they own the underlying security.

A protective put is an options strategy that can be used to hedge against the risk of a potential loss of an underlying security. It involves buying a put option contract, for a fee or premium, on a security the investor already holds in their portfolio. By definition, a put option gives the option buyer, the right to sell a fixed number of shares at a predetermined price during a bracketed period of time.

In effect for a fixed period, a put option contract acts as an insurance policy in case the share price of the security declines. If the security increases rather than decreases in value, the investor loses the premium but could still benefit from any share price appreciation on the underlying stock.

If the share price goes down, the investor can, before the end of the option contract's term (expiration date) sell their protective put which normally would have increased in value or exercise their right to sell the stock at the higher strike price.

Picto inspiration

Please note, if the investor doesn’t close (sell) their put option that is in the money at expiration, the shares will be exercised and sold at the strike price. 

Why use a protective put?

While most investors who buy stocks or ETFs expect share prices to increase over the long term, the typical stock price chart rarely follows a straight upwardly sloping line. Increases happen in fits and starts, interspersed by lulls and downturns.

There will be periods where the share price declines for different reasons. If an investor believes that there is a risk of a short- to medium-term decrease in the share price and would like to take advantage of it or wants to protect stock holdings in case the decline is permanent, a protective put would be an option to consider.

The combination of paying for a protective put option and holding the stock gives an investor the ability to hedge against a share price decline with the option. At the same time, and if things take an unexpected turn and the share price increases, they still benefit since they own the underlying stock.

The cost of the protective put includes the premium and the commissions charged for the option trade. If the shares continue to increase over the long term, the cost of the put option premium could be considered a small price to pay. Like purchasing travel insurance for a vacation, a protective put is a way to buy peace of mind during periods of market volatility.

If the share price declines, the investor can either exercise the option at the predetermined strike price which is higher than the current share price or sell the put option for a profit and collect the premium, before expiration and hold onto the shares and wait for them to recover.

How does a protective put work?

A protective put is a two-part transaction. Each part involves several steps that you’ll need to consider, starting when you buy a protective put options contract and then again when you close out your position. Here is a breakdown of the process.

Part 1: Initiating and buying the protective put

  • a) Own an eligible stock: You must own an option-eligible stock or ETF. Ideally, your mid- to long-term outlook on the stock is bullish, but changing market or sectoral conditions lead you to believe that the share price could decrease in the coming days or weeks.
  • b) Decide on the strike price: Do you want the strike price to be close to the stock or ETF's actual price or somewhat below?  The choice of expiration date and strike price will determine the cost of the premium you end up paying for the put option.
  • c) Choose the expiration or maturity date: Determine your time frame for downside protection and then select an appropriate expiration date for the protective put – a week, a month, 3 months, or more.
  • d) Buy the put option: To protect against this possible decrease, you buy a put option on the underlying security.

Part 2: Monitoring and closing out your position

  • a) The protective put is active: Once you have decided on the expiration date, strike price, and paid the premium and commission, you become the owner of a put contract for the underlying stock.
  • b) Option expiration: As the protective put option nears expiry there are three possibilities:
    • If the share price has increased and is above the strike price the put option is considered 'out of the money.' This means that the option will be worthless by the time it reaches the expiration date.
      or
    • If the share price has decreased, the put option is 'in the money.' It may now be worth more than the price paid and you could sell it at a profit. 
      or
    • If the share price has decreased, you can, in principle, exercise your right to sell the stock at the pre-established strike price. Most traders do not go this far. The usual approach is to close out your position and profit from the sale of the options contract while holding onto the underlying stock.
Picto inspiration

It is important to remember that for out-of-the money
options, the further the expiration date and the closer the option price is to the current price (in-the-money), the higher the premium amount.

Protective put: An example

In August 2024, Alex purchased 200 shares of ABC company in her TFSA account at a price of $50.00 each. Since then, the shares have gone up. They now trade at $100 a share, doubling her initial $10,000 investment.

In the past week, a competitor operating in the same sector released a weak earnings report that caused share prices to drop by over 40%.

Even though the outlook on ABC company remains positive for the long term, Alex is concerned that when ABC releases its earnings report two weeks from now, it might also disappoint investors and lead to a significant drop in share price.

Alex doesn’t want to sell her shares, but how can she protect herself from a potential loss? Here’s a possible solution:

  • Alex keeps her 200 shares in ABC company.
  • She buys two put contracts. Each contract is equivalent to 100 shares of ABC company. She sets the contract expiration 30 days from the purchase date and sets the strike price at $100.
  • The premium to purchase the put contracts is $3.00 per share. Assuming no commissions, Alex's total cost to buy the two puts is $600: 2 put contracts = $600 =2 x 100 shares x $3.00/share.

Possible outcomes:

Scenario #1: ABC company releases better than expected results and the shares climb to $115.00 and are predicted to go up even higher. Alex's shares of ABC company have increased in value by over $3000, and if they continue to rise, she will benefit even more. The two put options are 'out of the money' and now worthless. Alex loses the $600 she paid for the contracts but profits from the stock price increase.

Scenario #2: ABC company releases disappointing results and shares are trading at $80. The put options are expiring in a few days, and the contracts are trading at a premium of $20 per share. Since the put options are deep 'in the money,' Alex has the choice of selling them, closing her position, and collecting the premium. If she sells her put options , she will receive $4,000 = 2 contracts x 100 shares x $20/share. After taking into account the $600 she paid to buy the put option protection, she is ahead $3,400 and still holds the underlying shares.

The amount Alex receives from selling her put options does not cover or hedge against all the loss in value of the underlying holding. Nevertheless, compared to doing nothing, the protective put generated positive returns and placed her in a better financial position. Since she is following a long-term investment strategy, she wants to hold onto her ABC shares, hoping they will increase in value over the coming months or years.

Scenario #3: ABC company releases disappointing results and shares are trading at $80, the put options are expiring in a few days and are deep 'in the money.' Alex is no longer sure about the long-term prospects for ABC company. Instead of selling the option contracts and collecting the premium, she decides to exercise the two put options on the contract expiration date.

In this situation, an entity that sold the option contracts will be assigned to buy Alex's 200 ABC company shares at the pre-agreed strike price of $100 a share even though they are now trading at $80 a share. Alex receives $20,000 for the shares but had to pay $600 for the put option protection. Alex is left with $19,400. Since the transaction happened in her TFSA brokerage account she will not be subject to a capital gains tax. Additional fees may apply. Please refer to our options pricing for details.

How to trade options on your brokerage account?

Investors have several different options strategies to take advantage of. Each one offers a different way to speculate and manage risk within a portfolio. Some are more complex to implement than others and as a consequence, are used by more experienced investors.

Some option strategies require particular kinds of investment accounts. For example, investors who want to use cash secured puts require a margin account, while covered calls and protective puts, once approved, are available to investors using any type of investment account.

NBDB clients who see an options tab when they open a transaction ticket on a buy or sell order already have access to buying calls and puts. If not, making a request is easy. Just contact NBDB via the online messaging centre by clicking the envelope icon on your NBDB Trading Platform page.

Conclusion

A protective put is one way to hedge against a potential decline in a stock or ETF that an investor holds in their portfolio. Like any insurance policy, investors should do their research and evaluate the costs and potential benefits of buying a protective put option. In addition to taking advantage of the online resources available on the NBDB platform, knowing how to use a protective put is a useful and practical tool to have in your investment toolkit. Keep in mind that every investment decision involves risk. Understanding the tools available can help you better manage that risk and make informed choices. As you expand your knowledge, you’ll gain more confidence in your financial decisions.

Further reading

Here are some articles and tools available on the NBDB website that you can consult to learn more and guide you on your self-directed investing journey:

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Learn more about options strategies

Key takeaways

  • A protective put is an options strategy used to hedge against a decline in a stock or ETF in an investment portfolio.
  • Unlike timing the market, a protective put lets an investor benefit when a stock or ETF in their portfolio goes down in value without having to sell the underlying stock.
  • On expiration, if the underlying stock is above the strike price, the protective put is 'out of the money,' in which case the investor loses the premium paid.
  • If the stock is below the strike price, it is 'in the money,' and the investor can sell their protective put option or exercise their right to sell the underlying stock at the options strike price that is higher than the market price.

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Tags:
Options 101, Investment strategies