protective put strategy

mensatrader

Active member
183 0
Hi all

protective put strategy involves long equity and long put option. My question is as follows:

strike is K, and current stock price is S. Amercian put option is always worth more than the corresponding European put option (under same strike and maturity), since American put option is sometimes worth its intrinsic value K-S, it must hold true that the corresponding European put is sometimes worth less than its intrinsic value K-S, so does it mean that when the European put is worth less than the intrinsic K-S, I implement the protective put by buying the European put with premium p (less than its intrinsic K-S), then the worst case would be I only make profit of (K-S)-p?

Many thanks!
 

Hittfeld

Well-known member
437 12
Well, I know both assignment modes, but I wasn`t aware that both option types were available for the very same underlying/strike/expiration combination.

Regards
 

mensatrader

Active member
183 0
Well, I know both assignment modes, but I wasn`t aware that both option types were available for the very same underlying/strike/expiration combination.

Regards

thanks, you mean it is impossible for both types to have the very same underlying/strike/expiration combination?
 

Hittfeld

Well-known member
437 12
Yeah, I thinks there`s always only ONE exercise style permitted per options contract specification. If both styles are required (S&P100) they are different products: OEX (american) XEO (european).

Regards
 

mensatrader

Active member
183 0
Yeah, I thinks there`s always only ONE exercise style permitted per options contract specification. If both styles are required (S&P100) they are different products: OEX (american) XEO (european).

Regards

thanks.

but I can't understand mathematically why it is not possible to have minimum positive profit of (K-S)-P for protective put when it is possible to have european put that has less value than its intrinsic value of K-S?
 

Hittfeld

Well-known member
437 12
Without going to answer your question: You are aware that your protection with europ. style is LESS than with american style? So you can`t set to equal what is different (not only premiumwise).

Regards
 

mensatrader

Active member
183 0
Without going to answer your question: You are aware that your protection with europ. style is LESS than with american style? So you can`t set to equal what is different (not only premiumwise).

Regards

Sorry, I don't understand what you mean?

I think European put value can be less than its intrinsic value sometimes so mathematically it seems possible to always have positive profit (minimum profit is K-S-premium). But obviously there should be no strategy that can 100% guarantee a profit. right?
 

mensatrader

Active member
183 0
just take a simple example: current stock price $3, strike price for a European put is $5, it seems possible for the European put to have premium less than ($5-$3)=$2, say $1.8 premium (because an American put can be worth its intrinsic $2 and american put is worth more than the european put). so it is possible for the protective put strategy to always have positive profit, right? Minimum profit is $5-$3-$1.8=$0.2. I know this should be a mistake but I don't know where I am wrong??
 

MacroStyle

Junior member
11 1
No ITM option will ever be worth less than it's intrinsic value. Think about it this way, if you were the market maker why would you sell an ITM option for less than it's intrinsic value, ensuring that you make a loss?
 

mensatrader

Active member
183 0
No ITM option will ever be worth less than it's intrinsic value. Think about it this way, if you were the market maker why would you sell an ITM option for less than it's intrinsic value, ensuring that you make a loss?

thank you! That makes sense!

But it's just I read from the 'options, futures, and other derivatives' that, european put options should be sometimes worth less than the corresponding american put when the american put is worth its intrinsic.
 

Martinghoul

Senior member
2,690 276
thank you! That makes sense!

But it's just I read from the 'options, futures, and other derivatives' that, european put options should be sometimes worth less than the corresponding american put when the american put is worth its intrinsic.
I'm pretty sure that it's just the cost of carry, that's all...
 
 
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