Hedging Strategies

Options can be used to protect existing stock positions against adverse price movements. These protective strategies are important for the Series 7 exam.

Protective Put (Married Put)

A protective put involves buying a put option while owning the underlying stock. It protects against downside risk while allowing unlimited upside potential.

Example

• Own 100 shares of XYZ at $50
• Buy 1 XYZ 50 Put @ $3

The put acts like insurance - if the stock falls, the investor can sell at $50 regardless of market price. The $3 premium is the "insurance cost."

Exam Tip: A protective put creates a "floor" under the stock position. The investor gives up some upside (the premium) for downside protection.

Covered Call

A covered call involves writing a call option while owning the underlying stock. It generates income but limits upside potential.

Example

• Own 100 shares of XYZ bought at $48
• Sell 1 XYZ 55 Call @ $2

The investor is "covered" because they own the shares to deliver if the call is exercised.

Exam Alert: Covered calls are the most conservative option writing strategy. They generate income but cap the upside at the strike price.

Collar Strategy

A collar combines a protective put with a covered call on the same stock. It provides downside protection while reducing or eliminating the cost of the put.

Example

• Own 100 shares of XYZ at $50
• Buy 1 XYZ 45 Put @ $2
• Sell 1 XYZ 55 Call @ $2

This creates a "costless collar" because the premium received from selling the call pays for the put.

When to Use Each Strategy

Comparison of Hedging Strategies

Important: Covered writing is considered suitable for conservative investors seeking income, while naked (uncovered) writing involves substantial risk and is unsuitable for most retail investors.