Protective Calls & Protective Puts
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Protective Calls
Protective calls involve the short sale of an underlying asset along with a long call option. This strategy offers you some insurance against price rises of underlying assets you’ve short sold. One set of protective calls is purchased for every 100 underlying assets short sold.
The strike price should be the same as (or as close as possible to) the initial short sale price. If the market price is above the strike price at expiration, you simply exercise the option. You will purchase the underlying asset, forcing the call writer to sell the asset at a price worth less than its market price. The purchased underlying is used to close the short sale, reducing the losses you’ve incurred from the price rise.
If the market price is below the strike price at expiration, you simply keep the underlying asset and let the call options expire. The premium paid slightly reduces your gains.
Protective Puts
Protective puts involve the purchase of an underlying asset along with a put option. This strategy offers you some insurance against price declines of underlying assets you’ve purchased. One set of protective puts is purchased for every 100 underlying assets short purchased.
The strike price should be the same as (or as close as possible to) the initial short long purchase. If the market price is below the strike price at expiration, you simply exercise the option. You will sell the underlying asset, forcing the put writer to purchase the asset at a price worth more than its market price. You receive more than the asset’s market price, reducing your losses. The sold underlying is used to close the long purchase, reducing the losses you’ve incurred from the price decrease.
If the market price is above the strike price at expiration, you simply keep the underlying asset and let the put option expire. The premium paid slightly reduces your gains.
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