How to Utilize Protective Puts During Earnings Season

Protective puts may benefit your portfolio amid volatility

Deputy Editor
Apr 25, 2024 at 11:44 AM
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The second quarter is well underway, and the accompanying earnings season is rife with shakeups. The last few weeks were filled with massive post-earnings moves, especially from tech players including Meta Platforms (META), Spotify Technology (SPOT), and Tesla (TSLA).

Alongside a swath of quarterly updates, investors are eagerly awaiting the Federal Reserve's upcoming interest rate decision, which will add even more volatility to the trading landscape. Don't fret, though, because we're going to take a look at how traders can utilize options to protect their profits.

A Protective Put Breakdown

One way traders can "insure" their investment and limit losses in the event of a major move lower is through protective puts. A protective put locks in a selling price (the strike) for the shares, just in case they take a turn for the worse.

For instance, let's say you bought 100 shares of Stock XYZ at $100 apiece, and they're now trading at $120. However, earnings are around the corner and you're scared the stock may give up some or all of those gains -- but you don't want to sell the shares just yet and miss out on additional upside. You could purchase a 110-strike protective put that encompasses the earnings release. That way, if XYZ tumbles back to the century mark after earnings, the protective put allows you to unload your shares at $110 -- locking in a 10% profit (minus the cost of the puts).

As such, the main goal of a protective put buyer is quite different than that of a “vanilla” put buyer. A protective put buyer is simply using the option as a form of insurance if the stock tanks; the trader's ultimate goal is for the shares to move higher -- and ideally offset the cost of the option -- leaving the put to expire worthless. A "vanilla" put buyer is actively looking for the underlying shares to fall.

Weighing the Risks

While the protective put buyer's goal is to forfeit the initial premium paid for the put -- which represents the maximum risk on the trade -- you don't want to overpay. Against this backdrop, it's important to select the right strike and options series to accommodate your personal risk tolerance.

It is also important to be aware of the risks when trading options ahead of big events such as earnings. When a company has a planned event like earnings on the horizon, options premiums tend to be inflated. As a result, deeper out-of-the-money puts will be more affordable to purchase, but will allow less protection in the end.

In addition, the cost of the protective puts depends on time value. A 110-strike put that expires in two weeks will cost less than a put at the same strike expiring in two months, as the latter allows more time for the underlying stock to make a big move.

 

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