A protective put is an option contract that hedges against losses in a long stock position, by allowing the investor to sell the underlying security at a specific price.

Sometime investors will seek to limit possible losses in a stock that they hold by purchasing a put option at a price below the current market price. This allows the investor to sell their stock at a set price if it takes a dive for any reason. Let’s assume that you have 100 shares of company ABC, which is trading at $100/share.

Purchasing a put with a strike price of $90/share for the next three months (let’s say for $5/share) guarantees that you can sell your shares at the strike price at any time during the three months. Therefore, if the price of the stock falls below $85, which is the breakeven price($90 strike minus $5 premium), your protection was worth it. Otherwise, you lost the premium but got a good night’s sleep for these three months.