An investor purchases ABC stock at $71 per share and executes a protective put strategy. The put option used in the strategy has a strike price of $66, expires in two months, and is purchased for $1.45. At expiration, the protective put strategy breaks even when the price of ABC is closest to: A. $64.55. B. $67.45. C. $72.45. C is correct because to break even, the underlying stock must be at least as high as the amount expended up front to establish the position. To establish the protective put, the investor would have spent $71 + $1.45 = $72.45. ____________________________________ I am confused with the above explantion as strike price is only $66 so to break even stock need to go down to 64.55 to make the premium paid. Can someone help me understand it. Thanks,
For protective put : breakeven = share price + option cost ie 71+1.45=72.45.
*its not exercise price + option cost
They are asking for the breakeven for the strategy, not just the option.
If the stock goes down to $64.55 he will exercise the put, earning a 1.45 profit, which will cancel out the 1.45 he paid as a premium. At the same time it will be as if he sold the stock for $66, so that’s a $5 loss on the stock.
If the stock goes to 72.45, he will not exercise the put, losing the 1.45 premium, but at the same time he will gain 1.45 on the stock, breaking even.
yeah this question is all about the STRATEGY of a protective put. Just rememeber you are long the underlying also. Yes you make money on the put option when the price drops, but you are also losing your ass on the underlying.
@ neerajkr : Im getting an idea which thing confuses you. So let me explain some imp points and Im pretty much sure it wont confuse you in future:
The two strategies (standard) Puts and protuctive puts are different , not the same so dont mix them up.
The difference is: in Puts you dont own the underlying asset and the idea behind this strategy is; you purchase this option to get the right to sell the underlying. If the market price goes down you exercise the option by purchasing the underlying from the market at lower price and sell at the strike price which is higher. So difference is your profit (less option premium) . If market price goes up you simply wont exercise the option (in case you exercise then you have to purchase the underlying at higher price and sell at lower,strike, price) max loss is the on premium you paid at start.
Now come to Protective Puts: in this strategy you own the underlying. once you already purchased the underlying you can make profit only when price of the underlying goes up. you purchase put option (long) only to minimize losses. You can’t make any profit in this strategy if market price of the underlying goes down even if the strike price is lower.
So what are you doing actually, trying to answer the protective put strategy question by thinking it a puts strategy.
@ jackKicker explains the the strategy and its results very well.
Thanks Very much @Raza Sysed and other . This certainly helps… i was so confused