Protecting Long Term Investments · Options Trading Guide
A put spread hedge reduces premium by limiting the put payoff. Below the lower strike, the stock holding can resume losing value without additional option protection.
Build the bounded hedge
Against owned shares, buy a higher strike put and sell a lower strike put with the same expiration. The short put reduces the premium cost but caps the hedge payoff at the strike width. The option spread can limit its own loss while the combined stock holding still carries substantial downside risk.
Follow the protection through three prices
Hold 100 shares at $100 and buy a 95 put while selling an 80 put for a net $3 debit. Combined starting cost is $10,300. At expiration at $90, shares are worth $9,000 and the spread $500, for a total $9,500 and an $800 loss. At $80, shares plus the $1,500 spread are also $9,500. At $60, total value is only $7,500, producing a $2,800 loss.
Recognise the renewed downside
Between $95 and $80, the put spread offsets additional share declines at expiration. Below $80, its payoff stays at $1,500 while the shares continue falling. This is a protected band, not a floor for every possible price. It can be appropriate only when that limited protection matches the intended risk objective. Calling the whole stock position defined risk would conceal the largest adverse scenarios.
Treat index hedges as estimates
A portfolio of individual stocks hedged with index puts introduces basis risk. A rough beta adjusted notional can help size a starting hedge, but beta changes and company specific news may dominate. Test different portfolio and index moves rather than assuming they fall together by the same percentage. Record multiplier, currency, expiration and settlement differences. Compare the spread hedge with a full put or reducing exposure before deciding whether lower premium is worth leaving the deep tail unprotected.
Try it yourself
A 100 share holding loses another $10 per share after the underlying is already below a put spread hedge’s lower strike. How much extra expiration protection does the spread add?
Show the worked answer
None. The spread payoff is already capped. The additional stock decline reduces combined value by $1,000.
Further reading
Educational material. Examples and rates are hypothetical, not trade recommendations. Product terms, eligibility and risks vary by venue and jurisdiction.
