Protective puts: ATM, ITM or OTM?

lazy_eyed_ladykiller

Junior member
11 1
What do you prefer? OTM is obviously the cheapest: stock is trading at 50, I go long 49 put. WHat if by expiry the stock lands at 49.50? Would I be losing .50$ on the shares as WELL as the put premium?

ATM: fixes the issue of the stock lying in the ''deadzone", but is more expensive than OTM.

ITM: with a put strike above the stock, say at 51, gives me room to add more to my position to average my cost still below the put strike by expiry so I don't land in the dead zone with the put expiring unexercised, and my stock in a losing position. I basically eliminate all possibility of the put unexercising if my stock is below the strike. Down side: it's friggin expensive.

So what are your thoughts? OTM/ATM/ITM?
 

options-george

Well-known member
483 93
What do you prefer? OTM is obviously the cheapest: stock is trading at 50, I go long 49 put. WHat if by expiry the stock lands at 49.50? Would I be losing .50$ on the shares as WELL as the put premium?

ATM: fixes the issue of the stock lying in the ''deadzone", but is more expensive than OTM.

ITM: with a put strike above the stock, say at 51, gives me room to add more to my position to average my cost still below the put strike by expiry so I don't land in the dead zone with the put expiring unexercised, and my stock in a losing position. I basically eliminate all possibility of the put unexercising if my stock is below the strike. Down side: it's friggin expensive.

So what are your thoughts? OTM/ATM/ITM?

If the stock is trading $49.50 at expiry, then yes, you would be down $0.50 on the stock, and the put option would be worthless - on expiration the put is only worth something if the stock is less than $49.

The reason for buying protective puts is basically insurance policy. With car or house insurance you are not really trying to protect yourself against small losses but rather against disasters. You should think of protective puts in the same way. Thus you wouldn't buy a 49 strike but something like the 45 strike. This of course depends on the general volatility of the stock, too.

You should not think of a put option as a sure way to avoid a loss on a stock trade. You are just trying to protect yourself against huge unexpected moves.

For example you might want to buy a protective put prior to a company's earnings announcement, because you are scared that a bad earnigns numbers will make the stock gap below your stop loss level. The put option would protect you there.

Remember that the time value of your option premium (regardless whether it's OTM, ATM or ITM) will decay over time. So this will always into the profit of your stock position.

I hope that helps a little.
 
 
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