Overview
A protective call is also known as a synthetic long put. It is a trading strategy that is used by the investors who have sold the stock and want to protect themselves from any kind of unexpected price increases. This strategy involves not only selling but shorting a stock and also buying a call option to hedge against the losses, if the stock price rises. By using this approach investors can easily make profits.
How Protective Call Works
In this strategy the investor sells a stock and also buys a call option at the current market price. This call option could be ATM that is At The Money or slightly OTM Out of The Money. The call option acts like an insurance against a sudden increase in stock prices. If the stock prices rise unexpectedly, the call option will increase its value and reduce the chances of losses due to the shorted stock.
Benefits of a Protective Call
Here are some advantages of using this strategy:
- Limited Risk: The loss is capped because the call option provides protection against rising prices.
- Potential Profit: If the stock price declines, the investor benefits from the short position.
- Cost Efficiency: Unlike buying a put option, this method involves receiving money from selling the stock while still hedging against risks.
- Market Protection: It is ideal for investors who expect stock prices to fall but want a safety net in case of a rise.
Conclusion
A protective call strategy will help investors in managing risks while also maintaining potential profits in a changing market. It provides protection against any unexpected price increases and makes it a useful tool for traders.
